16.3. HOW TO WEIGH YOUR BORROWING ALTERNATIVES 629
Table 16.6:People’s Bank of China interest rates, late 2006lending rate savings rate
3 months 1.80%
6 months 5.58% 6 months 2.25%
6-12months 6.12% 1 year 2.52%
1-3 years 6.30% 2 years 3.06%
3-5 years 6.48% 3 years 3.69%
>5 years 6.84% 5 years 4.14%Table 16.6. The lending rates are, in fact, the People’s Bank’s reference rates. The
central bank is, indeed, the entity that decides on reference interest rates for loans,
but it also sets a band within which local bank branches have some discretion in
adjusting their lending rates. As of 1999, the band is 10% below and 30% above the
reference rate and for loans to large enterprises, the upper limit is 10% above the
reference rate. According to Garca-Herrero et al. (2005), due to the banks’ lack of
expertise in accessing borrowers’ credit risk, most loans are just contracted at, or
even below, thePBC’s reference rate despite the additional flexibility provided by
the liberalization of interest rates.
An uncritical spreadsheet-adept could calculate that the borrowing rate for best-
quality borrowers would be the rate at the bottom of the People’s Bank admissible
range,i.e. 6.84% ×0.90 = 6.156%. The corresponding risk spread would then
be 6.75% - 6.156% = 0.594%. Below, then, are shown the calculations using that
stand-in for the risk-free rate; the corresponding annuity factor is 5.551,560,664. I
show thenpvand total-spread calculations:
Example 16.8 CNYalternative
risk spreads (PV) (1600× 0. 00594 × 5. 551 , 560 ,664)/ 8 .00 = usd6,595,254
upfront 1600 × 0. 01 / 8 .00 = 2,000,000
total cost 8,595,254
equivalent annuity 8,595,254/5.551560664 = 1,548,259
same, in percent 1,548,259/200m = % 0.774
YIELD("1/1/2001","12/31/2007",0.0575,99,100,1,1) = % 6.935
risk-free proxy % 6.156
all-in spread % 0.779
So far so good—but what is the point of the calculations? We do not really have a
risk-free rate: 6.156 is a possible lower bound that is, however, rarely applied. If we
had worked with 6.5 as the risk-free proxy, the equivalent annuity would have been
calculated as 0.25% above 6.5%, and theIRRat 0.435% above it, not 0.77-0.78%.
We could even make a case for using the midpoint rate rather than a borrowing