Question
Consider the situation of firm A and firm B. The current exchange rate is $2.00/ Firm A is a U.S. MNC and wants to borrow
Consider the situation of firm A and firm B. The current exchange rate is $2.00/ Firm A is a U.S. MNC and wants to borrow 30 million for 2 years. Firm B is a British MNC and wants to borrow $60 million for 2 years. Their borrowing opportunities are as shown, both firms have AAA credit ratings.
$ | |||||||
A | $ | 6 | % | 5 | % | ||
B | $ | 7 | % | 4 | % | ||
The IRP 1-year and 2-year forward exchange rates are
F1($)=$2.00 (1.06)1.00 (1.04)=$2.03851.00F1($)=$2.00 (1.06)1.00 (1.04)=$2.03851.00
F2($)=$2.00 (1.06)21.00 (1.04)2 = $2.07771.00F2($)=$2.00 (1.06)21.00 (1.04)2 = $2.07771.00
USD | pounds | |||||||||||||||
Bid | Ask | Bid | Ask | |||||||||||||
6 | % | 6.1 | % | 4 | % | 4.1 | % | |||||||||
Explain how firm B could use the forward exchange markets to redenominate a 2-year 30m 4 percent-pound sterling loan into a 2-year USD-denominated loan.
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