In the ’97-98 crisis the Thai baht first fell 24% (July 97), finally reached 60% over the entire period (July ’97 through Sept 98). During this period when you had to repay the loan the fall (depreciation for a floating rate) was 50%. What is the profit (loss) you made on this 4 million dollar loans?
Now in the new environment after the crisis with your floating exchange rates and assuming you did not go bankrupt with your losses from the foreign exchange depreciation you have another $400 million loan.
You have a default risk your statisticians estimate at 5%. You ask currency experts for the estimated probabilities of foreign exchange depreciation over the next year: they estimate no change at 50%, a 10% decline at 30%, a 20% decline at 15%, a 30% decline at 5%. The initial exchange rate value when you received the loan was 100 Baht per dollar. You want to have a return of 5% after accounting for the risk premiums of default and exchange rate variation. So, what is your total charge for the loan as a percentage and in absolute?
(Assume that your default and exchange rate probabilities are made accurately by your bank experts or the consulting services you use and you are not including the costs of these consulting services in calculating the total interest costs you will charge.)