Question
GBA Company wishes to raise $6,000,000 with debt financing. The funds will be repaid with interest in 1 year. The treasurer of GBA Company is
GBA Company wishes to raise $6,000,000 with debt financing. The funds will be repaid with interest in 1 year. The treasurer of GBA Company is considering three sources:
1) Borrow USD from Citibank at 3.00%
2) Borrow EUR from Deutsche Bank at 5.50%
3) Borrow GBP from Barclays at 4.50%
If the company borrows in euros or British pounds, it will not cover the foreign exchange risk; that is, it will change foreign currency for dollars at today's spot rate and buy foreign currency back 1 year later at the spot rate prevailing then. The GBA Company has no operations in Europe. A representative of GBA contacts a local academic to provide projections of the spot rates 1 year in the future. The academic comes up with the following table:
Currency | Spot Rate | Projected Rate 1 Year in the Future |
USD/GBP | 1.45 | 1.48 |
USD/EUR | 0.97 | 0.93 |
- What is the expected interest rate cost for the loans in EUR and GBP?
- What are the projected USD/GBP rate and USD/EUR rate for which the expected interest costs would be the same for the three loans?
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