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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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