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Information on current spot rates and interest rates are retrieved as follow: Spot exchange rate (MYR/EUR) 4
Information on current spot rates and interest rates are retrieved as follow:
Spot exchange rate (MYR/EUR) 4.8600
Spot exchange rate (MYR/NZD) 2.7500
Three-month MYR interest rate 4.00% p.a.
Three-month EUR interest rate 2.00% p.a.
Three-month NZD interest rate 6.00% p.a.
ENVY Berhad is considering to raise short-term foreign currency loans in euro (EUR) and New Zealand dollar (NZD) for three months to finance its working capital needs. It plans to borrow 65% in EUR and 35% in NZD. Required:
(i) Assume that international parity conditions hold, predict future spot exchange rates of MYR/EUR and MYR/NZD by the end of three months. Then, calculate the percentage change in spot rate for EUR and NZD against MYR respectively. (10 marks)
(ii) Calculate the portfolio effective financing rate for ENVY Berhad. Evaluate whether this portfolio of foreign currency loans is appropriate if ENVY Berhad is concern about the potential exchange rate risk. (10 marks)
Expert Solution
| Spot rate | MYR/EUR | 4.86 |
| MYR/NZD | 2.75 | |
| Interest Rate | MYR | 4% |
| EURO | 2% | |
| NZD | 6% | |
| Spot rate(MYR/EUR)/ Future(MYR/EUR)= (1+interest rate (MYR))/(1+interest rate(EUR)) | ||
| 4.86/Future spot rate=(1+.005)/(1+.01) | ||
| Future spot rate(MYR/EUR)=4.86*1.01/1.005 | ||
| Future spot rate(MYR/EUR) | 4.88 |
Future spot rate(MYR/NZD)=2.75*1.01/1.015 =2.736
% Change in Spot rate (4.88-4.86)/4.86*100=.4115% for EURo against MYR
% change in spot rate= (2.74-2.75)/2.75=-.3636%
Effective financing rate= .65*
(ii) Effective interest rate for EURO=(1+.02/12*3)^3-1=1.51%
and effective interest rate for NZD= (1+.06/12*3)^3-1= 4.57%
So Portfolio effective interest rate=.65*1.51+.35*4.57%=2.581%
Portfolio effective interest rate is 2.581%. So fund will not flow from ENVY berhad to EURO and Newzealand as the effective interest for the loan is lower than domestic interest rate.
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