Question 2b
The directors of Plam Co expect that interest rates will fall over the next year and they are looking forward to paying less interest on the company’s debt finance. The dollar is the domestic currency of Plam Co. The company has a number of different kinds of debt finance, as follows:
| Loan notes | Loan notes | Bank loan | Overdraft | |
|---|---|---|---|---|
| Denomination | Dollar | Peso | Dollar | Dollar |
| Nominal value | $20m | 300m pesos | $4m | $3m |
| Interest rate | 7% per year | 10% per year | 8% per year | 10% per year |
| Interest type | Fixed rate | Fixed rate | Variable rate | Variable rate |
| Interest due | 6 months’ time | 6 months’ time | 6 months’ time | monthly |
| Redemption | 8 years’ time at nominal value | 8 years’ time at nominal value | Instalments over 8 years | Continuing at current level |
The 7% loan notes were issued domestically while the 10% loan notes were issued in a foreign country.
The interest rate on the long-term bank loan is reset to bank base rate plus a fixed percentage at the end of each year.
The annual payment on the bank loan consists of interest on the year-end balance plus a capital repayment.
Relevant exchange rates are as follows:
| Offer | Bid | |
|---|---|---|
| Spot rate (pesos/$) | 58·335 | 58·345 |
| Six-month forward rate (pesos/$) | 56·585 | 56·597 |
Required:
(b) Identify and discuss the different kinds of interest rate risk faced by Plam Co. (5 marks)