Assume a U.S.-based MNC is borrowing Romanian leu (ROL)at an interest rate of 8% for one year.Also assume that the spot rate of the leu is $.00012 and the one-year forward rate of the leu is $.00010.The expected spot rate of the leu one-year from now is $.00011.What is the effective financing rate for the MNC assuming it borrows leu on a covered basis

Question

Quizplus · Accepted Answer

Effective financing rate = (1 + foreign interest rate)/(1 + forward premium/discount) - 1
= (1 + 0.08)/(1 + (-0.00002/$0.00012)) - 1
= -0.099 or -9.9%
Since the expected spot rate in one year is lower than the forward rate, there is a forward discount, which results in a negative effective financing rate. Therefore, the correct answer is B) -10%.