The 7% loan notes were issued domestically while the 10% loan notes were issued in a foreign country.
The interest rate on the long-term bank loan is reset to bank base rate plus a fixed percentage at the end of each year. The annual payment on the bank loan consists of interest on the year-end balance plus a capital repayment.
Relevant exchange rates are as follows:
Plam Co can place pesos on deposit at 3% per year and borrow dollars at 10% per year. The company has no cash available for hedging purposes.
Required:
(a) Evaluate the risk faced by Plam Co on its peso-denominated interest payment in six months’ time and advise how this risk might be hedged. (5 marks)
(b) Identify and discuss the different kinds of interest rate risk faced by Plam Co. (5 marks)