Topping-Up Clause
Categories: Banking
We were anxious about opening a branch of No Filter, our selfie consulting firm, in Costa Rica. But then we met Fred, owner of a sloth-inspired apparel company in San Jose, and all our fears were allayed. Fred wanted to open a new shop here in the United States, and once we learned that, an idea began to form. We decided to enter into a little arrangement with Fred: No Filter would offer him a loan for $500,000 USD so he could get his shop set up here in the States, and Slothwear, Inc. would offer us a loan of ₡288,018,500 (that’s the approximate value of $500,000 in Costa Rican colóns) so we could get our business going in Costa Rica. This is what’s known as a parallel loan.
Our particular parallel loan comes with what’s known as a “topping-up clause,” which is oh so handy for businesses like ours that are looking to get started in a new country, but are maybe a little wary about potential currency fluctuations and devaluations. This clause says that, if one currency gets devalued, the borrower of that currency has to make payments to reset the equilibrium between the loan amounts. If the currency gets revalued, then the lender of that currency is the one who has to make payments.
The goal of the topping-up clause is to make sure that the two loans are as close to equal as possible. Because if the dollar suddenly drops in value but the colón does not, then our loan to Fred is suddenly worth less than his loan to us, which is no fair. The topping-up clause exists to make sure that doesn’t happen.
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Finance: How does foreign exchange work?11 Views
Finance allah shmoop how does foreign exchange work All right
Well there's risk when you buy and sell goods and
services outside of the u s that isn't there when
you buy and sell goods inside the u s your
smoothies and absence a major chain of a thousand smoothie
shops you buy a million bananas a year the customers
believe that they have a peel you buy all of
them plantains actually these little guys from uganda and just
agreed to pay in ugandan shillings One u s dollar
buys about four thousand ugandan shillings and that's a lot
of bananas You take the risk on the foreign exchange
currency because well you don't like hedging your bets you're
just going to take the risk if the currency moves
up or down it's on you horse at another way
Yeah if you were nervous about relative currency valuation fluctuations
well you could be a kind of currency life insurance
in paying a ten or twenty percent premium above where
the relative currencies air trading today that for thousands of
one thing and you could sleep pretty well at night
knowing that your rates were fixed like you're basically paying
Someone else to take the risk of uganda suddenly getting
its financial act together in its currency skyrocketing so that
a u s dollars only buys you three thousand or
two thousand ugandan shillings or things go the other way
But you don't like buying insurance You know how nice
the jets are that insurance executives fly and you know
about warren buffett He didn't get there for free so
you didn't had you didn't do anything to worry about
currency but then all of a sudden china decides to
adopt uganda as its new financial partner agreeing toe underwrite
all of uganda's debts basically in return for well uganda
Yeah they liked owning uganda way better weather and they
also got the highly prized you r l uganda dot
com So then almost literally overnight the ugandan shilling becomes
highly more valued under the deeply respected and feared auspices
of the chinese banking system So instead of a dollar
buying you for thousand schillings while now a u s
dollar only buys you one thousand so your cost of
bananas just went from four hundred bucks a ton to
sixteen hundred bucks and the marginal cost of those banana
Plantain Things in your shakes went from thirty cents over
a dollar twenty and with profit margin per shake it
only two fifty to start with twelve new profit margins
suddenly dropped almost in half Eventually you'll have to find
another banana supplier or raise prices or figure out a
substitute But well for now it looks like this Foreign 00:02:29.253 --> [endTime] exchange deals Profits will get eating