Exhibit 20-1
Assume a U.S.-based MNC is borrowing Romanian leu at an interest rate of 8 percent 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.
-Refer to Exhibit 20-1 above. What is the effective financing rate for the MNC assuming it borrows leu on an uncovered basis?

Question

Quizplus · Accepted Answer

The effective financing rate is the interest rate adjusted for the expected change in the exchange rate. In this case, the expected change in the exchange rate is a depreciation of the leu, which means that the MNC will have to pay more leu to repay the loan in one year. This will increase the effective financing rate. The effective financing rate can be calculated as follows:Effective financing rate = Interest rate + (Expected change in exchange rate / Spot exchange rate)Effective financing rate = 8% + (0.00011 - 0.00012) / 0.00012Effective financing rate = 8% - 8.33%Effective financing rate = -0.33%Therefore, the effective financing rate for the MNC is about -0.33%.

Exhibit 20-1 Assume a U.S.-Based MNC Is Borrowing Romanian Leu at an at an Interest