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HI All
Hope the revision is going well.
In chapter 18 of the opentuition revision notes in example 6
we borrow $5m dollars at 5.8% and we wish to convert to £ right now. but we will only borrow for 3 months. so the interest rate is 1.45%
In the answer it shows we calculate the interest by $5m / 1.0145 = $4,928,536 and this is how much we convert to sterling.How does this make sense? $5,000,000 less $4,928,536 = $71464 we have paid this much interest for the 3 month loan.
But i think we should pay 1.45% which is $5,000,000 X 0.0145 = $72500
I am wrong in my 72500 calculation but can anyone explain why please
Many thanks for your help
We are not borrowing $5M dollars. If we did, then the interest would be $72,500, but then we would not be able to repay the borrowing because we only receive $5M from the customer.
The whole point of the exercise is to decide how much we can afford to borrow now, given that we will receive $5M in 3 months
If we borrow $4,928,536, the the interest will be 1.45% x $4,928,536 = $71,464.
This mean that in 3 months time we will owe a total of 4928536 + 71464 = $5M.In three months time we receive $5M from the customer and therefore we will be able to repay the borrowing.
If you watch my lecture on this then the reasoning should become clear.
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