- 20 Marks
Question
Zakaria Construction Plc. (ZCP) are your customers specialized in the construction of highways. Sometime in February, your customer approached you to discuss their intention to apply for a Bid Bond to participate in an International Competitive Tender by the Ministry of Roads and Highways. The Tender is for the award of a contract to construct the Eastern Corridor Road. After discussions with your bank, the Bid Bond was issued in Favour of Ministry of Roads and Highways. On March 1, Mr. Adamu, the Chief Finance Officer of ZCP, called to inform you that the company has successfully won the Tender and had been awarded a contract to construct a portion of the main project. At the meeting, Mr. Adamu showed other documents confirming the award of the contract – which also showed the contract value as USD1.2million. The meeting discussed at length, how the bank could assist ZCP to obtain an Advance Payment Bond in Favour of Ministry of Roads and Highways to enable the company access $11.25 %$ initial Mobilization Funding of the contract value.
The following events took place: a. On April 1, the Advance Payment Guarantee was issued and submitted to the Ministry of Roads and Highways. b. The $11.25 %$ Advance Payment Funding is confirmed by Ministry of Roads and Highways and will be received by your bank exactly in three months’ time, on July 1, for customer’s account. c. Also on April 1, the company entered into three months’ Forward Contract to sell the US Dollar proceeds of the $11.25 %$ Advance Payment to your bank on arrival of funds.
ZCP has to acquire materials before main construction works begin in July and so, have requested your bank for immediate funding and have proposed two options as follows: I) To borrow the US Dollar amount of the $11.25 %$ Advance Payment for three months and repay when it is received on July 1. ii) To borrow Ghana Cedi equivalent of the US Dollar amount for three months and repay from proceeds of the three months Forward Contract.
Rates available for the day are as follows:
| April 1, | Spot | 10.2570 |
|---|---|---|
| One month forward | 0.0085 | 10.2640 |
| Two months’ forward | 0.0115 | 0.0095 cedis discount |
| Three months’ forward | 0.0135 | 0.0125 cedis discount |
| 0.0145 cedis discount |
You are also given the following additional information: a. Term SOFR (Secured Overnight Financing Rate) which has replaced the LIBOR, is quoted this morning for 3 months US Dollar at $5.1 %$ with your bank’s margin at $4.5 %$. b. Commitment and Arrangement Fees are charged separately on Dollar borrowing at $1.50 %$ and $0.50 %$ respectively. c. Interest and other charges on US Dollar borrowing should be translated at middle-rate. d. For ZCP, your bank will lend local currency at $2 %$ above its Base Rate of $21.75 %$ p.a. e. Processing Fees for Cedi Facility is $1.0 %$. f. Cedi Facility also attracts Group Insurance Commission of $1.50 %$.
REQUIRED Calculate each of the two options and choose the most favorable one from your customer’s point of view, stating your reason.
Answer
To solve this, first determine the advance payment amount and key exchange rates from the given data. The contract value is USD 1,200,000, and the advance payment is 11.25% of this value.
Advance payment = 1,200,000 × 0.1125 = USD 135,000.
The spot rate is interpreted as USD/GHS 10.2570 (bid) – 10.2640 (offer), with forward points as cedis discounts (added to spot rates). For three months: bid points 0.0135, offer points 0.0145.
Middle rate = (10.2570 + 10.2640) / 2 = 10.2605.
Three-month forward rate bid = 10.2570 + 0.0135 = 10.2705.
Three-month forward rate offer = 10.2640 + 0.0145 = 10.2785.
Since the customer is selling USD under the forward contract, the applicable rate is the forward bid rate of 10.2705.
GHS proceeds from forward sale = 135,000 × 10.2705 = GHS 1,386,517.50.
Option i: Borrow USD 135,000 for three months, repay principal with incoming funds on July 1.
Loan interest rate = SOFR 5.1% + margin 4.5% = 9.6% p.a.
Assuming a 360-day year (standard for USD loans), interest for 3 months (90/360 = 0.25) = 135,000 × 0.096 × 0.25 = USD 3,240.
Commitment fee = 135,000 × 0.015 = USD 2,025.
Arrangement fee = 135,000 × 0.005 = USD 675.
Total charges (interest + fees) = 3,240 + 2,025 + 675 = USD 5,940.
Translate to GHS at middle rate: 5,940 × 10.2605 = GHS 60,947.37.
The customer receives USD 135,000 immediately, which can be converted to GHS at the spot bid rate (10.2570) for GHS 1,384,695 to fund materials. The principal is repaid with the incoming USD 135,000, and the charges are paid in GHS equivalent. Thus, total cost = GHS 60,947.37.
Option ii: Borrow GHS equivalent of USD 135,000 for three months, repay from forward contract proceeds.
GHS equivalent at spot bid rate (consistent with conversion in option i) = 135,000 × 10.2570 = GHS 1,384,695.
Loan interest rate = base 21.75% + 2% = 23.75% p.a.
Interest for 3 months (assuming 90/360 = 0.25) = 1,384,695 × 0.2375 × 0.25 = GHS 82,216.27.
Processing fee = 1,384,695 × 0.01 = GHS 13,846.95.
Group insurance commission = 1,384,695 × 0.015 = GHS 20,770.43.
Total charges (interest + fees) = 82,216.27 + 13,846.95 + 20,770.43 = GHS 116,833.65.
The customer receives GHS 1,384,695 immediately. On July 1, forward proceeds of GHS 1,386,517.50 are used toward repaying principal + interest (GHS 1,384,695 + 82,216.27 = GHS 1,466,911.27), resulting in a shortfall of GHS 80,393.77 (covered from other sources). However, the total cost calculation focuses on the explicit interest and fees, adjusted for the forward gain (1,386,517.50 – 1,384,695 = GHS 1,822.50), but the net cost remains higher at GHS 116,833.65 (as the gain is minimal compared to charges).
Comparison and recommendation:
- Option i total cost: GHS 60,947.37
- Option ii total cost: GHS 116,833.65
The most favorable option from the customer’s point of view is option i (borrowing in USD), as it incurs a significantly lower total cost (approximately 48% less) due to the lower interest rate on USD borrowing (9.6% p.a.) compared to the high GHS lending rate (23.75% p.a.), despite fees and translation. The forward discount provides only a small offsetting gain in option ii, insufficient to bridge the gap. This aligns with practical advantages of foreign currency loans in Ghana when USD rates are lower, subject to BoG forex regulations and customer risk appetite for currency exposure.
- Tags: Advance Payment Bond, bid bond, Fees, Forward Contract, GHS Loan, Interest calculation, SOFR, USD Loan
- Level: Level 3
- Topic: Foreign Currency Borrowing, Forward Contracts, Local Currency Borrowing
- Series: APR 2024
- Uploader: Salamat Hamid