Finding the Implicit Interest Rate on Loans Using the Swap Rates

Assume the following rates are quoted in the yen/dollar swap market:
Yen/LIBOR 5year yen rates ! "#5$% &i#e#' pay "#5$% yen rate to get LIBOR(
)ollar/LIBOR 5year dollar rates ! *#5$% &i#e#' re+ei,e *#5$% dollar rate -y paying LIBOR(
Yen/)ollar rate ! &Yen/LIBOR(/&)ollar/LIBOR( ! Yen/)ollar ! ."#5$%//*#5$%
0hat is' R1R +an e2+hange "#5$% yen rate for *#5$% dollar rate# I am using hypotheti+al swap
rates for illustration# You would ha,e to use the a+tual rates gi,en in 32hi-it * of the R1R +ase#
4ow +onsider the following a+tual yen-ased +ash flows of the dual+urren+y -ond:
$ 5 6 7 8 5
9:::::::::::::9:::::::::::9::::::::::::::::9:::::::::::::9:::::::::::::::9
.68'*$"#65 .5*7;#5 .5*7;#5 .5*7;#5 .5*7;#5 .5*7;#5
/555#*5
0he R1R wants to e2+hange the interest payments in yens &not the prin+ipal dollar payments in
year 5( o,er the ne2t fi,e years with its equi,alent in dollars o,er the ne2t fi,e years using the
."#5$%//*#5$% swap rate# <e +an find the => of these fi,e equal payments of .5*7;#5 at a
dis+ount rate of "#5$%# 0he => is .?$55#*6# 0his => +an -e +on,erted to its equi,alent in
dollars using the +urrent spot e2+hange rate of .67"#?$//@ the +on,ersion gi,es /78#$$7# 4ow
we +an find the equi,alent of /78#$$7 in fi,e equal dollar-ased' annual installments using the
dollar rate of *#5$%# 0he annual dollar payment +omes out to -e /?#?55# 0he original re+eipts of
R1R of .68'*$"#65 +on,erts to /5$5#57 at the e2+hange rate of .67"#*$//# Ao our re,ised dollar
-ase +ash flows using the swap rate of ."#5$%//*#5$% are:
$ 5 6 7 8 5
9:::::::::::::9:::::::::::9::::::::::::::::9:::::::::::::9:::::::::::::::9
/5$5#57 /?#?55 /?#?55 /?#?55 /?#?55 /?#?55
/555#*5
Ain+e all the +ash flows are in dollars' we +an estimate the IRR to find the dollar-ased impli+it
interest rate# 0he IRR is 5$#5$5%# Ao this is the final fi2ed interest rate that R1R would pay for
the dual+urren+y -ond after hedging the yen-ased interest payments into dollar using the swap
+ontra+ts#
In the +ase of 3uroyen -onds' -oth the interest payments o,er the ne2t fi,e years and the final
prin+ipal payment in year 5 are in yens# Ao -oth the interest and prin+ipal in yens need to -e
swapped into its equi,alent in dollars# 0he steps to get the dollar-ased IRR are similar to those
a-o,e for the dual+urren+y -onds# 0hat is' find first the => of yen-ased interest and prin+ipal
using the "#5$% yen rate' and then +on,ert that => to its equi,alent in dollars &dollarequi,alent
=>( using the rele,ant +urrent spot e2+hange rate# R1R will pay an annual interest rate of *#5$%
on this dollarequi,alent => and also pay it -a+k in 5 years# &Alternati,ely' we +an also +al+ulate
the B> of this dollarequi,alent => using *#5$% and then estimate IRR#(
0his dollar-ased => +an -e ,iewed as the new prin+ipal at year $# 0he R1R would pay annually
an interest rate of *#5$% on the new prin+ipal as well as pay -a+k the new prin+ipal in 5 years
using the swap +ontra+t# 0he final dollar-ased +ash flows for IRR will look as follows: original
+ash inflow of dual+urren+y -ond +on,erted from yens re+ei,ed to dollars at year $ &i#e#'
/5$7#?55 million(' fi,e equal dollar-ased' annual interest payments as negati,e +ash flows from
years 5 to 5 using the *#5$% rate' and the final negati,e +ash flow equal to the new prin+ipal
&i#e#' dollar-ased =>(##