McDonnoughs Hamburger Company wishes to lend $500,000 to its Japanese subsidiary. At the same time, Tsunami Heavy Industries is interested in making a medium-term loan of approximately the same amount to its US subsidiary. The two parties are brought together by an investment bank for the purpose of making parallel loans (a form of currency swap). McDonnoughs will lend $500,000 to the US subsidiary of Tsunami for four years at 13 percent. Principal and interest are payable only at the end of the fourth year, with interest compounding annually. Tsunami will lend the Japanese subsidiary of McDonnoughs 70 million yen for four years at 10 percent. Again the principal and interest (annual compounding) are payable at the end. The current exchange rate is 140 yen to the dollar. However, the dollar is expected to decline by 5 yen to the dollar per year over the next four years.
a. If these expectations prove to be correct, what will be the dollar equivalent of principal and interest payments to Tsunami at the end of four years?
b. What total dollars will McDonnoughs receive at the end of four years from the payment of principal and interest on its loan by the US subsidiary of Tsunami?
c. Which party is better off with the parallel loan arrangement? What would happen if the yen did not change in value?