Question

New Hampshire Corp. has decided to issue​ three-year bonds in​ Russia, denominated in​ 5,000,000 Russian rubles at par. The bonds have an annual coupon rate of​ 17%. New Hampshire Corp does not expect to have ruble cash flows to repay the​ bonds, so they must convert U.S. dollars to rubles to make interest and principal payments on the bonds. The current spot rate is Rub​ 33.3333/$. Assume relative PPP holds between Russia and the U.S. If inflation in Russia is​ 5% and is​ 1% in the​ U.S., and is expected to remain constant over the​ three-year life of the​ bonds, what is the annual U.S. dollar financing cost of these​ bonds? ​ (HINT: Draw a timeline with the annual Rub cash​ flows, the annual exchange rates and the annual USD cash flows on​ it.)

A.

​10.66%

B.

​12.54%

C.

​14.87%

D.

​19.29%

Answer 1

Year	Debt	Interest	Total Rubles	Opening Spot rate	Applicable Forex rate	Amount in USD- Ruble cashflow / Forex rate
0	(5,000,000)		(5,000,000)	33.3333	33.3333	$   (150,000.15)
1		850,000	850,000	33.3333*1.05/1.01	34.6534	$      24,528.60
2		850,000	850,000	33.3333*1.05^2/1.01^2	36.0258	$      23,594.17
3	5,000,000	850,000	5,850,000	33.3333*1.05^3/1.01^3	37.4526	$    156,197.39
Calculation of IRR	12%	13%
Year	Board game	PV factor, 1/(1+r)^t	PV factor, 1/(1+r)^t	PV@12%	PV@13%
0	$      (150,000)	1.0000	1.0000	$            (150,000.15)	$ (150,000.15)
1	$          24,529	0.8929	0.8850	$               21,900.53	$    21,706.72
2	$          23,594	0.7972	0.7831	$               18,809.13	$    18,477.70
3	$        156,197	0.7118	0.6931	$             111,178.22	$ 108,252.63
			NPV	$                 1,887.73	$     (1,563.10)
		IRR	=Lower rate + Difference in rates*(NPV at lower rate)/(Lower rate NPV-Higher rate NPV)
		IRR	'=12%+ (13%-12%)*(1887.73/(1887.73+1563.1)
		IRR	12.54%