Question

East Asiatic Company—Thailand. The East Asiatic Company​ (EAC), a Danish company with subsidiaries throughout​ Asia, has been funding its Bangkok subsidiary primarily with U.S. dollar debt because of the cost and availability of dollar capital as opposed to Thai​ baht-denominated (B) debt. The treasurer of​ EAC-Thailand is considering a​ 1-year bank loan for $249,000. The current spot rate is B32.07​/$, and the​ dollar-based interest is 6.76​% or the​ 1-year period. ​ 1-year loans are 11.97​% in baht.

a. Assuming expected inflation rates of 4.5​% and 1.22​% in Thailand and the United​ States, respectively, for the coming​ year, according to purchase power​ parity, what would the effective cost of funds be in Thai baht​ terms? (Round to three decimal places).

b. If​ EAC's foreign exchange advisers believe strongly that the Thai government wants to push the value of the baht down against the dollar by 5​% over the coming year​ (to promote its export competitiveness in dollar​ markets), what might the effective cost of funds end up being in baht​ terms?

c. If EAC could borrow Thai baht at 13.00​% per​ annum, would this be cheaper than either part​ (a) or part​ (b) above?

Answer 1

a) Loan amount in $ 249000.00

Spot rate 32.07

Loan amount in Thai Baht 7985430.00

Loan amount to be refunded at 6.76% in $ 265832.40

Spot rate based on inflation differential 33.1092 =32.07*(1+4.5%)/(1+1.22%)

Amount in Thai Baht 8801502.76

Effective rate in Thai Baht 10.22%

b) Loan amount in $ 249000.00

Spot rate 32.07

Loan amount in Thai Baht 7985430.00

Loan amount to be refunded at 6.76% in $ 265832.40

Spot rate based on 5% depreciation 33.6735 =32.07*(1+5%)

Amount in Thai Baht 8951507.32

Effective rate in Thai Baht 12.10%

c) No 13% would be still more expensive than both options