Page 7 of 16 8. Interest rate parity: a. Merton Co. is a U.S. based firm that needs to borrow $125 million for one year. It can borrow in the United States for 7% or in Canada for 12%. It has no other Canadian dollar cash flows and no other international business. Interest rate parity holds. Merton expects the Canadian dollar will depreciate but that the rate of depreciation will be less than the current forward discount on the Canadian dollar. The current spot rate for the Canadian dollar is $.70. Compare the expected borrowing costs from the three strategies below. Which strategy has the highest expected borrowing cost? Explain your answer. i. Borrowing in the United States ii. Borrowing in Canadian dollars and simultaneously purchasing the Canadian dollar forward iii. Borrowing in Canadian dollars and without covering the Canadian dollar position b. Scholes Co. is a U.S. based firm that has $125 million available to lend for one year. It can lend in the United States for 10% or in Australia for 6%. It has no other Australian dollar cash flows and no other international business. Interest rate parity holds. Scholes expects the Australian dollar will appreciate but that the rate of appreciation will be less than the current forward premium on the Australian dollar. The current spot rate for the Australian dollar is $.62. Compare the expected lending revenue from the three strategies below. Which strategy below has the lowest expected yield? Explain your answer. i. Lending in the United States ii. Lending in Australian dollars and simultaneously selling the Australian dollar forward iii. Lending in Australian dollars without covering the Australian dollar position