A U.S. firm can borrow either from the US bank or from

Question

A U.S. firm can borrow either from the US bank or from Japanese bank. Interest rate on borrowings from the US bank is 10% p.a. If the US firm borrows from the Japanese bank, the Japanese bank charges 1% upfront fees of the borrowing amount. Both banks require that interest and principle be repaid at the end of the year. The borrowing from the Japanese bank can converted into US$ at JPY 130 per US$. This conversion rate a year after is JPY 125 for a US$. 

What interest rate on borrowings from the Japanese bank will make the U.S. firm indifferent between the two loans?

Sorry for not having OA. Just for discussion.

jaspetrovic · Answer

Hi, 
I used $100 as borrowed amount..
My ans. would be that we have to have borrowed $110 from both US and Japanese bank at the end of the year, so that company would be indifferent.

If we transfer $110 to Japanese money, we would have to have borrowed from the Japanese bank 110*125=15000 JPY.
At the beginning of the year the transformation rate is 130 JPY for one $US, so $100-$1 (one percent upfront)=99*130=12870
So at the end it is 15000 â€“ 12870 = 2130 (interest)

To get interest rateâ€¦ (2130/12870)*100=16.55%

Himalayan · Answer

Thanks jaspetrovic for your effort.

Though I do not have OA but the rate cannot be more than 10% because Japanese bank is charging you 1% upfront fee. To offset this fee, the Japanese bank should charge less than 10% to make the borrowing comparable with the US bank.

kevincan · Answer

Suppose P is borrowed from the American bank. 1.1P must be returned at the end of the year.

Whatever the firm borrows from the Japanese bank, 1% is withheld as a surcharge, so to receive P, the firm must borrow P/0.99, which in yen at JPY 130 is 130P/0.99. If the interest rate is r% p.a. , the firm will have to return 130P(1+r)/0.99 yen or 130P(1+r)/(0.99*125) dollars at the end of the year.

So we get 1+r= 1.1*125*0.99/130
r=(1.1*25*0.99/26) -1= 4.7% approx

A U.S. firm can borrow either from the US bank or from

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