Question

Ahemba Ltd is a fast growing Ghanaian Multinational Company looking for short term working capital loan to support its expansion to other West African Countries. You have just been hired as a senior Financial Analyst to help the firm secure a cheap source of funding to achieve its objective. The CEO of this company is concern about the high interest rates in Ghana and has asked you to borrow in Dollars since USD interest rates are cheaper. You have your own reservations about borrowing in USD due to exchange rate risk and looking for figures to explain to him.

You had a chat with your relationship manager of your corresponding bank and are willing to lend USD 10million to you for 1 year at an interest rate of 4% which is far better than the current interest rates of 16.74% prevailing on the domestic market. Your intention is to convert this into Ghana Cedis and use for your expansion program. The current exchange rate is 4.53 per USD and is forecasted to be 5.25per USD in a year’s time.

a) Calculate the effective annual Financing Cost of the USD Loan

b) Assume that Interest rate Parity (IRP) holds and that you intend to hedge the exchange rate risk by entering into a 1 year Forward transaction with your Bank. What will be the effective annual interest rate in this case?

Answer 1

Exchange rate = 4.53 Ghana Cedis/USD

$10,000,000 = 45,300,000 Ghana Cedis

Interest =         4% of $10 million

            =          $400,000

It is assumed that the interest is paid throughout the year and hence is converted to Ghana Cedis at average exchange rate of (4.53 + 5.25)/2 = 4.89/USD

So, the interest in Ghanian Cedis is 1,956,000 Ghanian Cedis.

Total amount =          45,300,000 + 1,956,000

                        =          47,256,000 Ghanain Cedis

Converting to USD at 5.25/USD = 47,256,000/5.25 = $9,001,143