Question

Turkish subsidiary of an US company wants to borrow TL500 mn for 5-years for factory capacity expansion investment. Annual interest rate on a 5-year loan for 5 years is 10% in TL and 5% in USD. Spot rate of USDTL is 7 and TL is expected to appreciate by 5% each year in the next five years. Compare and decide which debt denomination is better (US$ or TL).

Answer 1

Amount to borrow = TL500 million

Duration = 5 years

Rate of Interest in Turkey = 10% while it is 5% in US

Spot rate of USD to TL is 7 which means 1 Dollar can buy 7 Lira or 1 Lira can buy $0.14. After 5 years, Lira appreciate by 5% each year which means 1 Lira can buy $0.182 or 1 dollar can buy 5.48 Lira.

If you convert TL500 million into dollar that would be 500 * 0.14 = $71.42 million. After 5 years, amount payable in dollar would be 71.42 * (1 + 0.05)5 = $91.16 million. After 5 years, $91.16 million can buy 91.16 * 5.48 = TL500 million

If you keep money in Lira, amount payable after 5 years would be 500 * (1 + 0.1)5 = TL805.25 million

Thus, US$ is better option to repay the loan.