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In his final presentation, he noted that even if the dollar weakened to its lowest point in that 10-year
span of time, the effective interest would rise but not enough to make the interest payments
uneconomical. His argument carried the day and the loan was made.
As you may guess, I am telling this story because disaster lay ahead. Let‟s do the math that the
assistant treasurer did (Exhibit 7.23).
Borrow on January 1, 1985, at an exchange rate of 250 yen to the dollar. To get $200 million in
U.S. dollars, you would need to borrow $200 million times 250 yen to the dollar. That works out to be
¥50 billion.
So now the question becomes, what rate do we assume for the conversion?
If we assume 250 ¥/$, then our interest paid will be the ¥1.25 billion divided by 250 or $5 million.
If we assume that the rate will be 222.7 ¥/$, then the interest payment becomes ¥1.25 billion divided
by 222.7 or $5.6 million.
Compare this to the loan in U.S. dollars, even forgetting about the fee, and this is far superior: $200
million borrowed at 11% per year requires interest payments of $22 million each year, or $11 million
every six months. The savings is substantial.
The conclusion seemed clear. Even $5.6 million in interest was so far below the $11 million that
there really was no choice.
Dad: So what was missing?
Rodney: What about the options and futures markets?
Dad: At the time they were showing that the dollar would weaken substantially against the yen. Still,
that would not make the interest payment on the yen loan higher than the payment on the dollar loan.
What caused your problem with the CD that you bought in London?
Rodney: Oh! The problem there was the effect of the exchange rate on the principal. The assistant
treasurer focused on the interest payment and forgot about the principal.
Dad: Excellent. You are really thinking. You could have found the same answer listening to the
accountants. They require that each company mark the asset or loan to its value at the end of the
period.
Let‟s assume that the assistant treasurer was correct and that the yen strengthened to 222.7 ¥/$.
How much did the company pay in interest and how much did it owe at the end of the first year?
Let‟s make a table (Exhibit 7.24).