Long-Term Financing

FIN4802 Assignment 1 2015

Question 1

1. b
2. k
3. g
4. a
5. d
6. c
7. h
8. j
9. e
10. i
11. f

1. A fall in the value a value of a currency would make the currency cheaper and make imports in foreign currencies more expensive and exports less expensive. The current strong rand would encourage investors to invest abroad. It can cause the investors to purchase foreign currency (when investing) at when the exchange rate is lower than the exchange at which they would sell the currency (when the investment is liquidated). As Rand gradually weakens, you will find that investors would then be discouraged from investing abroad as this would cause investors to purchase foreign currency at an exchange rate that would be higher than the exchange rate at which they would sell the currency (when the investment is liquidated).

1. Standard Bank could facilitate the following financial transactions:

1. Short-Term Financing. Standard Bank could provide short-term loans to Dzata in the currency that is desired through the international money market (Standard Bank would be the creditor). Standard Bank could also accept short-term deposits in various currencies through the international money market.
2. Medium-Term Financing. Standard Bank could provide medium-term loans to Dzata in the currency that is desired through the international credit market (Standard Bank would be the creditor).
3. Long-Term Financing. Standard Bank could place bonds issued by Dzata in the international bond market (Standard Bank would serve as an intermediary rather than the creditor).
4. Foreign Exchange. Standard Bank could provide currency that was needed by Dzata in the foreign exchange market.
5. Standard Bank could also help Dzata place newly issued stock in foreign stock markets.

1. The subsidiary would prefer to borrow the currency that it uses to invoice its products. Thus, the future cash inflows would be in the same currency that is needed to pay back the loan, and exchange rate risk is avoided. Since the Namibian subsidiary probably invoices its products in Namibian Dollars, this is the logical currency to borrow. However, the high interest rate on the Namibian Dollar may cause the subsidiary to consider borrowing a different currency which would introduce risk. The currency borrowed would be converted to Namibian Dollars. In future, the Namibian Dollars will be converted to that currency to repay the loan. Thus, the risk is that the currency borrowed appreciates against the Namibian Dollar over the period of concern.

Question 2

1. Locational arbitrage is possible.

1. Buy Ringgit from Maybank (R1,000,000  3.151) = RM317,359.56[pic 1]
2. Sell  Ringgit to RHB Bank (RM317,359.56 × 3.152) = R1,000,317,35
3. Rand profit (R1,000,317.35 – R1,000,000) = R317,35

1. Triangular arbitrage is possible.

1. Exchange Rands for Ringgit (R1,000,000  3.151) = RM317,359.56[pic 2]
2. Convert the Ringgit into Japanese yen (RM317,359.56 × ¥32.69) = ¥10,374,484.01
3. Convert the Japanese yen into Rands (¥10,374,484.01 × R0.1057) = R1,096,582.95
4. Rand profit (R1,096,582.95 – R1,000,000) = R96,582.95

1. Covered interest arbitrage is possible

1. On Day 1, convert Rands to Ringgit and set up a 90-day deposit account at a Malaysian bank (R100,000  R3.151) = RM31,735.95[pic 3]
2. In 90 days, the Ringgit will mature to RM31,735.95 × 1.0375, which is the amount to be sold forward = RM32926.04
3. In 90 days, convert the Ringgit into Rand at the agreed-upon rate (RM32926.04 × R3.150) = R103,717.02
4. Rand amount available on a 90-day South African money market investment (R100,000 × 1.02) = R102,000.00
5. Rand profit excess above the Rand amount from money market investment (R103,717.02– R102,000) = R1,717.02

1. Arbitrage opportunities are likely to disappear soon after they have been discovered due to market forces. As a consequence of the actions taken by arbitrageurs, supply and demand for the foreign currency adjust until the mispricing disappears. For example, covered interest arbitrage involving the immediate purchase and subsequent sale of Ringgit would place upward pressure on the spot rate of the Ringgit and downward pressure on the Ringgit forward rate until covered interest arbitrage is no longer possible. Furthermore, this would cause interest rate parity, and the interest rate differential between the two countries is exactly offset by the forward premium or discount.

Question 3

1. ZAR spot rate under PPP = (1.111.05) x (10.09) = R10.66/dollar. [pic 4]
2. Expected ZAR spot rate = (1.081.10) x (10.12) = R9.93/dollar.[pic 5]
3. Expected ZAR under PPP = ((1.05)4  (1.07)4 ) x (10.12) = R9.38/dollar.[pic 6]

1. Yes, there is opportunity for currency arbitrage. Mr Brent would sell USD to Itau as they have the highest bid for USD and then buy USD from Bradesco because they have the lowest ask for USD. The profit is ($1,000,000 0.6166) – (1,000,000 0.6172) = 1,576.60 BRL[pic 7][pic 8]

Profit = 1,576.6 BRL  x 0.6172 to get that the profit $973.1 USD.

1. Yes it would still be profitable as $973.1 USD > $175 USD

$973.1 $1,000,000 = 0.09731%[pic 9]

If he had to pay 0.09731% from $1,000,000 USD, he would have to pay $973.1 USD for the transaction. This is the same value as the arbitrage profit which would break even.

1. To exploit interest rate arbitrage, he would need to borrow at the lower return and lend at the higher return.

1. Borrow at cheap U.S Interest rate 1,000,000 USD x 1.03  = 1,030,000
2. Sell USD and buy BRL at spot market 1,000,000  0.6166 = 1,621,796.95[pic 10]
3. Loan in BRL Bank 1,621,796.95 x 1.122 = 1,819,656.17BRL
4. Cover Loan 1,030,000 USD  0.5911 = 1,742,513.95BRL[pic 11]
5. Profit = 1,819,656.17 BRL - 1,742,513.95 BRL = 77,142.22 BRL

1. Borrow at high Brazilian interest rate 1,000,000 BRL x 1.131 = 1,131,000
2. Sell BRL and Buy USD at spot market 1,000,000 x 0.6149 = 614,900 USD
3. Loan in USD Bank 614,900 x 1.024 = 629,657.60 USD
4. Cover Loan 1,131,000 X 0.5889 = 666,045.90 USD
5. Loss = 614,900 – 666,045.90 = -51,145.90 USD

1. Clover should take advantage of the high returns from Brazilian interest rates and Low interest rates for US loans. Clover should borrow in USD, convert to BRL and invest in Brazilian bank to obtain a profit.