Happy Company wants to raise $2 million with debt financing. The funds are needed to finance working capital, and the firm will repay them with interest in one year. Happy Company's treasurer is considering three options:

a. Borrowing U. S. dollars from Security Pacific Bank at 8 percent.

b. Borrowing British pounds from Midland Bank at 14 percent.

c. Borrowing Japanese yen from Sanwa Bank at 5 percent.

If Happy borrows foreign currency, it will not cover it; that is, it will simply change foreign currency for dollars at today's spot rate and buy the same foreign currency a year later at the spot rate that is in effect. Happy Company estimates the pound will depreciate by 5 percent relative to the dollar and the yen will appreciate 3 percent relative to the dollar in the next year. From which bank should Happy Company borrow?

Question

Business

Kai Wilkinson

14 May, 10:10

Happy Company wants to raise $2 million with debt financing. The funds are needed to finance working capital, and the firm will repay them with interest in one year. Happy Company's treasurer is considering three options:

a. Borrowing U. S. dollars from Security Pacific Bank at 8 percent.

b. Borrowing British pounds from Midland Bank at 14 percent.

c. Borrowing Japanese yen from Sanwa Bank at 5 percent.

If Happy borrows foreign currency, it will not cover it; that is, it will simply change foreign currency for dollars at today's spot rate and buy the same foreign currency a year later at the spot rate that is in effect. Happy Company estimates the pound will depreciate by 5 percent relative to the dollar and the yen will appreciate 3 percent relative to the dollar in the next year. From which bank should Happy Company borrow?

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Answers (1)

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Dayton Cabrera · Answer 1

Happy Company will consider both capital expenses and foreign exchange threats.

If Happy's calculations are right, borrowing from Minland Bank is the best choice.

However, since forecasts are based solely on estimation, the choice is still centered on Happy Company's risk appetite, whether to take an 8 per cent flat rate, a strong 14 per cent rate, but with a chance of decline or a small 5 per cent rate, but with a possibility of appreciation.