Question

You are borrowing USD 1000 for one year, at a coupon rate of 8.3%. You will get the money today, and will repay all principal and interest one year from today. If the current CAD per USD spot rate is 0.83, the CAD inflation rate is 2.7%, and the USD inflation rate is 2.3%, what is the CAD cost of debt for this loan?

Answer 1

Maturity value of the loan to be repaid after 1 year in USD = Principal + coupon = 1,000 + 1,000 x 8.3% = 1,083

Exchange rate a year later = Spot rate x (1 + iCAD) / (1 + iUSD) = 0.83 x (1 + 2.7%) / (1 + 2.3%) = CAD 0.83325 / USD

Parameter	USD	Exchange rate (CAD / USD)	CAD
Amount borrowed at t = 0	1000	0.83	830
Amount to be paid back at t = 1 (Principal 1,000 + annual interest @ 8.3%)	1083	0.9631	1043.037

Hence, the CAD cost of debt for this loan = Amount paid back in CAD / Amount borrowed in CAD - 1

= 1043.08 / 830 - 1 = 25.67%