Question

Kato company needs one year loan of about Yens 80M. The company can borrow in Japan at 10.8% pa but is considering taking out sterling loan which could cost 6.56%. The current spot exchange rate is Yen/£ 5.1503. The company decides to borrow 40 M at 6.56% pa. Converting at the spot rate, this will provide Yen 51.503 million. Interest will be paid at the end of the year along with the repayment of loan and principal

Assuming the exchange rate moves in line with interest rate parity,

Required

1.         i.      Show the Yen values of the interest paid and the repayment of loan principal. (5 marks)
2.       ii.      Compute the effective interest rate paid on the loan (2marks)

Answer 1

Forward Rate :

=[(1+0.108)*5.1503]/1.0656

=5.355229

1. Interest Paid = 3.51303 Millions and Repayment of Loan Principal = 53.55229 Million

2. Effective Interest rate Paid = [(1+0.0656)/1]¹ -1

=0.0656