Might someone with background in currency trading and interest rate tell if following is true?
Sunday, June 6th, 2010 at
8:46 pm
If China increased value of Yen five percent, then would it not take 5% more dollars to pay interest on bonds. Would it be correct to say interest rate increased 5%. Since just stated seems too simple, is there a way to calculate effect of currency change on yield in dollars to state effect equivalent in interest rate?
Tagged with: bonds • china • currency change • interest rate • yen
Filed under: Uncategorized
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First, I think you mean Yuan (CNY). Yen is the currency of Japan (JPY).
Second, I think you might have confused the relationship between currency depreciation and appreciation. If China increases the value of the YUAN relative to the US Dollar, it would be demanding more US Dollars (USD) for every Yuan…in other words your first sentence don’t make sense to me.
Simple example (which may or may not work in the real world):
If the current exchange rate is 1 USD for 6.85 CNY, then a 5% appreciation of the Yuan would result in 1 USD for 6.50 CNY.
The problem answering your question directly is that your question seems to be assuming at least two things that aren’t actually true in the real world. (1) Currency changes are relative (between two particular currencies) not absolute (a country cannot use currency changes to simply increase prices, for example). (2) Debt repayment agreements (like bonds) are stated with repayment terms that often make your situation irrelevant.
(2 cont) For example, US Treasury bonds are payable in USD not the currency of the bond holder. An increase in the value of the Yuan would decrease the value of the interest payment to China in its home country by 5% but not change the actual value of the payout from US side of the equation.
On a $1 million bond a 2% annual interest payment is worth $20,000 UST. The UST is going to pay $20,000 USD per year to the holder in USD regardless of the value of the holder’s home currency. If the holder exchanges the USD for CNY, they will take a 5% loss (6850 less CYN), resulting in a net interest payment that is lower than 2%. If the bond is repaid as well, the principle will result in the same 5% loss if translated into the stronger home currency.
In absolute terms the interest rate expressed in Yuan is the same (2%). In relative terms, they have lost 5% across the board (349, 350 CYN).