Question

Ford (U.S. company) borrows $15 million in the U.S. capital market at the domestic interest rate of 10 percent per year and SONY (Japanese company) borrows1,650 million Japanese Yen in the Japanese credit market at the foreign interest rate of 6 percent per year. Each party then swaps the principal amount. The principal amounts are equivalent because the spot exchange rate is 110 Japanese Yen/1$. In this way, Ford has now borrowed Yen, and SONY has borrowed dollars. This is a 5 year foreign currency swap contract and interest payments are made once a year. (You know that they will make only net payments.) Suppose the spot exchange is 115 Japanese Yen/1$ at the end of year 1. Calculate which firm owes how much (in $ amount) to the other firm.

Answer 1

1. ford borrowed $15,000,000 which is 1,650,000,000(YEN){110YEN/DOLLAR} @ 6% in Japan costing an interest of 99,000,000 and due to the exchange rate of 110YEN/DOLLAR it will cost ford around $900,000 {99,000,000/110} but he borrowed money from US it had costed him around 1,500,000 {15,000,000*10/100} but now its costing just $900,000, which means ford is having a profit of $600,000.
2. at the end of the year 1 the spot rate changes to 115YEN/DOLLAR so now we know it has raised 1,650,000,000 yen@6% costing it around 99,000,000 and we also know if he had raised in the US he had to pay $15,000,000, but now if we have to see how much gain he had made at this 115YEN/DOLLAR spot rate we have to convert its YEN into DOLLAR, which is 99,000,000/115=860,869.57DOLLARS that means FORD has GAINED 639.130.43 {1,500,000-860,869.57}