The Transaction

• Client C takes a loan in Japanese Yen. While the current Dollar-Yen rate 124.35 it is proposed that the loan be drawn down at a Dollar-Yen rate of 120, which, at a constant Rupee-Dollar rate of 38.75, works out to 0.3229.
• The tenor of the loan is 13 months.
• The client takes on the Rupee-Yen exchange risk and keeps its position uncovered in order to save 17% p.a. on its Rupee cost of funds.

Risks

• C will be taking on a Rupee-Yen exchange risk. The Break-Even Rupee-Yen rate thus works out to 0.3778 at the end of the period. The possible combinations of Dollar-Rupee and Dollar-Yen which can make up this composite rate are given in sheet "break even" can be seen here. As can be seen, the Danger Points are 117.5 on USD-JPY and 42 on USD-INR.

Hedging

• It should be clearly understood C will earning 17% as a quid-pro-quo for accepting the Rupee-Yen risk. In fact, the transaction should only be entered into if C does not expect the Rupee to be 17% weaker against the Yen at the end of the loan period. The transaction will prove to be really beneficial if this view actually turns out to be true.
• In case C sees that the rates (either USDINR or USDJPY or both) are going against its view, it can hedge itself by taking a Forward Contract in the relevant currency. The Forward Contracts will have a cost attached to them, which will erode the benefit of the swap to that extent.
• The Dollar-Yen risk can be hedged using Currency Options also

Alternative Way of Achieving the same Objective
If C cannot access a straight Yen loan, but has a US-Dollar loan on its books, it can synthetically move to a Yen loan by entering into a Forward Contract to Buy Dollars / Sell Yen. The interest differential of close to 5% between the US Dollar and the Japanese Yen will be to the benefit of C.

Additional Benefit
The transaction is designed to enable C to gain not only the Interest Rate benefit, but also the benefit of Currency depreciation in case the Yen weakens against the Dollar and the Rupee. As mentioned earlier, we place an 80% probability of the Yen weakening to 135 against the Dollar over a 12 month time-frame and place only a 40% chance of the Rupee weakening to 42 against the Dollar by March.

 

	Current	Swap / Loan
	Rates	proposed
	1.00 pm, 19/2/98	at
USDJPY	124.35	120.00
USDINR	38.75	38.75
JPYINR	0.3116	0.3229
17%	0.3646	0.3778	<--- Break Even Rate

	US Dollar - Japanese Yen
Dollar-Rupee	110	112.5	115	117.5	120	122.5	125	127.5	130	132.5	135
45.00	0.4091	0.4000	0.3913	0.3830	0.3750	0.3673	0.3600	0.3529	0.3462	0.3396	0.3333
44.00	0.4000	0.3911	0.3826	0.3745	0.3667	0.3592	0.3520	0.3451	0.3385	0.3321	0.3259
43.00	0.3909	0.3822	0.3739	0.3660	0.3583	0.3510	0.3440	0.3373	0.3308	0.3245	0.3185
42.00	0.3818	0.3733	0.3652	0.3574	0.3500	0.3429	0.3360	0.3294	0.3231	0.3170	0.3111
41.00	0.3727	0.3644	0.3565	0.3489	0.3417	0.3347	0.3280	0.3216	0.3154	0.3094	0.3037
40.50	0.3682	0.3600	0.3522	0.3447	0.3375	0.3306	0.3240	0.3176	0.3115	0.3057	0.3000
40.00	0.3636	0.3556	0.3478	0.3404	0.3333	0.3265	0.3200	0.3137	0.3077	0.3019	0.2963
39.50	0.3591	0.3511	0.3435	0.3362	0.3292	0.3224	0.3160	0.3098	0.3038	0.2981	0.2926
39.00	0.3545	0.3467	0.3391	0.3319	0.3250	0.3184	0.3120	0.3059	0.3000	0.2943	0.2889
38.75	0.3523	0.3444	0.3370	0.3298	0.3229	0.3163	0.3100	0.3039	0.2981	0.2925	0.2870
38.50	0.3500	0.3422	0.3348	0.3277	0.3208	0.3143	0.3080	0.3020	0.2962	0.2906	0.2852
38.00	0.3455	0.3378	0.3304	0.3234	0.3167	0.3102	0.3040	0.2980	0.2923	0.2868	0.2815
37.50	0.3409	0.3333	0.3261	0.3191	0.3125	0.3061	0.3000	0.2941	0.2885	0.2830	0.2778
37.00	0.3364	0.3289	0.3217	0.3149	0.3083	0.3020	0.2960	0.2902	0.2846	0.2792	0.2741
Notes:
The cells in Red are the combination of Rupee-Dollar and Dollar-Yen rates at which the transaction goes Out of the Money