In: Finance
The U.S. Commerce Bank in St. Louis is trying to expand its overseas bank lending market. Now it has the opportunity to provide a profitable loan to the UK subsidiary of the local HGF Corporation. However, the bank has to obtain 50 Million PS for three months right away to fund the foreign loan, which will be repaid back in Pound Sterling (PS). The CFO has taken an international banking seminar and is aware of the Eurocurrency market that can be utilized to borrow in foreign currency. In light of the data given below for the Eurocurrency interact rates available to the market, the CFO of the bank is now evaluating the funding cost of the following three alternatives: 1. Borrow 3-month money in the Eurocurrency market in pounds sterling 2. Borrow one-month in the Eurocurrency market in Pound sterling and then roll over. 3. Borrow 3-month US dollars, change them into sterling at the spot rate and then hedge the repayment using the purchasing Pound sterling in the forward exchange market. Questions: What is the relative cost of each proposal? Which proposal should the CFO of the Commerce Bank take? Justify!
US Bank require to borrow Pound Str-50 million | |||||||
Options | |||||||
1 | Borrow 3 months Eurocurrency Market that can be utilize to borrow Pound | ||||||
2 | Borrow 1 month Eurocurrency Market that can be utilize to borrow Pound | ||||||
3 | Borrow 3 months US dollars spot & then hedge the same by converting into purchase pound at 3 months forward rate | ||||||
1 | If US Commerce bank borrow for 3 months pound steriling in euro market then 2 factors will affect the cost of transaction i.e. | ||||||
(1) Interest cost that need to be bear in euro market | |||||||
(2) Conversion rate of euro into pound at 3 month spot rate | |||||||
2 | If US Commerce bank borrow for 1 months pound steriling in euro market then 2 factors will affect the cost of transaction i.e. | ||||||
(1) Interest cost that need to be bear in euro market which will get fluctutate on ever month of roll over of such transaction | |||||||
(2) Conversion rate of euro into pound at each month spot rate will increase the cost of funding | |||||||
3 | If US Commerce bank borrow 3 months US dollars spot & then hedge the same by converting into purchase pound at 3 months forward rate then | ||||||
(1) Cost of funding (Interest rate) shall arises at the rate of US market in which bank is already having establised business. | |||||||
(2) Conversion in 3 month spot rate shall also be hedged by purchasing pound sterling at 3 month forward rate | |||||||
As per the given alternatives,best alternate is 3rd option which is least in cost of funding as compare to other cost. |