Question

New Hampshire Corp. has decided to issue​ three-year bonds in​ Russia, denominated in​ 5,000,000 Russian rubles at par. The bonds have an annual coupon rate of​ 17%. New Hampshire Corp does not expect to have ruble cash flows to repay the​ bonds, so they must convert U.S. dollars to rubles to make interest and principal payments on the bonds. The current spot rate is​ Rub33.3333/$. Assume relative PPP holds between Russia and the U.S. If inflation is​ 2% in Russia and​ 4% in the​ U.S., and is expected to remain constant over the​ three-year life of the​ bonds, what is the annual U.S. dollar financing cost of these​ bonds? ​ (HINT: draw a timeline with the annual Rub cash​ flows, the annual exchange rates and the annual USD cash flows on​ it.)

A.

​10.66%

B.

​12.54%

C.

​14.78%

D.

​19.29%

Answer 1

The annual dollar financing cost will be the IRR of the cash flows over the term of the bond.

The annual financing cost (in dollars) is 19.29% (option D)