Problem:
East Asiatic Company-Thailand. The East Asiatic Company (EAC), a Danish company with subsidiaries throughout Asia, has been funding its Bangkok subsidiary primarily with U.S. dollar debt because of the cost and availability of dollar capital as opposed to Thai baht-denominated (B) debt. The treasurer of EAC-Thailand is considering a 1-year bank loan for $250,000. The current spot rate is B32.06/$, and the dollar-based interest is 6.75% for the 1-year period. 1-year loans are 12.00% in baht.
a. Assuming expected inflation rates for the coming year of 4.3% and 1.25% in Thailand and the United States, respectively, according to purchase power parity, what would be the effective cost of funds in Thai baht terms?
b. If EAC's foreign exchange advisers believe strongly that the Thai government wants to push the value of the baht down against the dollar by 5% over the coming year (to promote its export competitiveness in dollar markets), what might be the effective cost of funds in baht terms?
c. If EAC could borrow Thai baht at 13% per annum, would this be cheaper than either part (a) or part (b)?