Quantum Inc., a U.S.-based corporation, borrows SF 2,000,000 from the Swiss bank
ID: 2766727 • Letter: Q
Question
Quantum Inc., a U.S.-based corporation, borrows SF 2,000,000 from the Swiss bank, UBS. The entire principal is to be repaid at the end of the year, and the interest rate is 4% per annum to be paid at the end of the year in Swiss francs. The current spot rate is SF 0.97/$.
a) Suppose that by year-end, the Swiss franc were to appreciate against the dollar by 10%. Compute the effective cost of the loan (i.e., the effective interest rate in USD)
b) Consider an alternative scenario. Suppose that by the end of the year, the franc were to depreciate against the dollar by 10%. Compute the effective cost of the loan (i.e., the effective interest rate in USD)
Explanation / Answer
Amount borrows = SF 2000000
Interest @4% = SF80000
Amount payable at end of year = SF2080000
10% appreciation in SF
Spot rate 1$ = 0.97SF
Year end rate 1.10$=0.97SF
1$ =0.97/1.10
1$ =0.88
in SF
1$=SF
in $
Start of year
Amount borrows
2000000
0.97
2061856
4% interest
80000
end of year
Amount payable
2080000
0.88
2363636
Effective interest rate = (2363636-2061856)/2061856
=14.64%
10% depreciate in SF
Spot rate 1$ = 0.97SF
Year end rate 1$ = 0.97SF
1$ =0.97*(110%)
1$ =1.07SF
in SF
1$=SF
in $
Start of year
Amount borrows
2000000
0.97
2061856
4% interest
80000
end of year
Amount payable
2080000
1.07
1943925
Effective interest rate = (1943925-2061856)/2061856
=-5.72%
in SF
1$=SF
in $
Start of year
Amount borrows
2000000
0.97
2061856
4% interest
80000
end of year
Amount payable
2080000
0.88
2363636