Question5 (6 marks) A NZ firm needs to borrow NZD 10 million for one year. It ca
ID: 1104902 • Letter: Q
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Question5 (6 marks) A NZ firm needs to borrow NZD 10 million for one year. It can borrow at a local bank at 6% per annum or it can issue bonds in Singapore denominated in Singapore dollars at 7% per annum. The current spot rate of Singapore dollar is 0.94 S$/NZS and the forecasted exchange rate in one year is 0.97 SS/NZS. (a) Calculate the expected percentage change in the value of Singapore dollar against NZ (2 Marks) (b) Is it cheaper for the NZ firm to borrow in New Zealand or Singapore? Show your dollar calculations to justify the answer (2 Marks) (c) What is the additional risk(s) involved in borrowing in Singapore? How could the NZ fimm (2 Marks) mitigate this risk(s) if it decides to borrow in Singapore?Explanation / Answer
5.
A.
Expected % change in Singapore $ against NZ $ = (.97-.94)/.94
Expected % change in Singapore $ against NZ $ = 3.19%
Hence, the value of Singapore $ will come down by 3.19% against the NZ$.
B.
When loan is borrowed in NZ $ in New Zealand.
The value of 10 Million NZ$ in one year = 10*(1+6%) = 10.6 Million
The value of 10.6 Million = 10.6*.97 = 10.282 Singapore $
When bond is issued in Singapore.
The value of 10 Million NZ$ = 10*.94 = 9.4 Singapore $
The value of 9.4 Million Singapore $ in one year = 9.4*(1+7%) = 10.058 Million Singapore $
It can be observed that if the bond is issued in Singapore Dollars, then only 10.058 Million Singapore $ is to be paid after 1 year, but if the loan is issued in NZ $ then 10.282 Million Singapore $ is to be paid. Hence, it is cheaper to issue the bond in Singapore in the denomination of Singapore $.
C.
Additional risk is the Forex currency risk, translational risk as well as the economic risk associated with the economy of Singapore. To mitigate such risk, the firm can choose to enter into the hedging strategy in the derivative market of future and options.
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