Zlick Company plans to invest $20 million in Chile to expand its subsidiaryâ€™s manufacturing output. Zlick has two options. It can convert the $20 million at the current exchange rate of 410 pesos to a dollar (i.e., P410/$1), or it can engage in a debt-for-equity swap with its bank, City Bank, by purchasing Chilean debt and then swapping that debt into Chilean equity investments.
a. If City Bank quotes bidâ€“offer prices of 94â€“96 for Chilean loans, what is the bank expecting to receive from Zlick Corporation (ignore taxes)? Why would City Bank want to dispose of this loan?
b. If Zlick decides to purchase the debt from City Bank and convert it to equity, it will have to exchange it at the official rate of P400/$1. Is this option better than investing directly in Chile at the free market rate of P410/$1?
c. What official exchange rate will cause Zlick to be indifferent between the two options?