Question

Suppose that on January 1 a firm in Mexico borrows $20 million from Citibank (USA) for...

Suppose that on January 1 a firm in Mexico borrows $20 million from Citibank (USA) for one year at 8.00% interest per annum. During the year U.S. inflation is 2.00% and Mexican inflation is 12.00%. The loan was taken when the spot rate was Peso 3.40/US$. At the end of the one year loan period the exchange rate was Peso 5.80/US$.

1. Based on the above information, what is the percent cost to the firm of the loan in Mexican pesos expressed as a per annum percentage?

2. Based on the information in Question 1, what is REAL percent cost of the loan to the firm in peso terms?

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Answer #1

Interest: 8%

Interest :$1.6M

In PESO: 20,000,000 x 3.40

                = 68,000,000 Peso

At the end of the year; repayment value:

Loan + Interest in USD = 21.6M

In PESO : 21,600,000 x 5.80

                = 125,280,000 PESO

Therefore, the percent cost to the firm of the loan in Mexican pesos expressed as a per annum percentage is 45.72%

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