I have a client with investment in South Africa. The client is based in US. The investment is currently under negotiation for sale at ZAR 15m (equivalent to USD 1m at today fx rates) but settlement is in 3 years. The receipts are in ZAR though we value the investment in USD. So instead of currently valuing the investment at $1m, i need to discount this value to take into account the 3 year settlement period. Which discount period should i use??? I guess i could value the investment at ZAR 15m at South African discount rates and then convert to USD at exchange rates (not sure which rates) OR value at USD 1m discount at US interest rates. I obviously dont get close results.
Depends whether you hedge the ZAR cash flows with forwards/futures. If all cash flows are locked at current rate you can use US discount rate. Otherwise, everything is in ZAR and USD return is irrelevant (client could decide on his own if he/she wants to hedge exposure).
not hedged.
The payment is in ZAR, so you need to discount 15 million ZAR using South African rates. Then, convert that present value to USD at current FX spot rates, which you can find quoted everywhere.
Alternatively, you can convert the future value of the ZAR payment to the future value of USD using the ZARUSD 3y forward rate. Then, discount that value using USD discount rates.
thanks