A firm forecasts the euro's value as follows for the next year:

The annual interest rate on the euro is 7 percent. The expected value of the effective financing rate from a U.S. firm's perspective is about:

Question

A firm forecasts the euro's value as follows for the next year:

The annual interest rate on the euro is 7 percent. The expected value of the effective financing rate from a U.S. firm's perspective is about:

Quizplus · Accepted Answer

To calculate the effective financing rate from a U.S. firm's perspective, we use the formula:

Effective Financing Rate = [(1 + Euro Interest Rate) / (1 + Expected Depreciation)] - 1

Expected Depreciation = (0.75 x 0.11) + (0.25 x 0.02) = 0.0875
(0.75 represents the probability of the euro depreciating, and 0.25 represents the probability of it appreciating)

Substituting the values, we get:

Effective Financing Rate = [(1 + 0.07) / (1 + 0.0875)] - 1 = 0.10959 or 10.959%

Therefore, the answer is choice B.

A Firm Forecasts the Euro's Value as Follows for the Next