If nominal interest rates are 5% in the United States and 8% in Mexico,you should convert the expected cash flows on your Mexican project into US dollars:
A) by assuming that the Mexican peso will appreciate by about 3% a year.
B) by assuming that the Mexican peso will depreciate by 8% a year.
C) by assuming that the dollar will appreciate by 5% a year.
D) by assuming that the Mexican peso will depreciate by about 3% a year.

Question

Quizplus · Accepted Answer

The best choice would be to assume that the Mexican peso will depreciate by about 3% a year. This is because the nominal interest rate in Mexico is higher than that in the United States, which can lead to a depreciation of the Mexican peso relative to the US dollar due to higher inflation expectations. By assuming that the Mexican peso will depreciate by about 3% a year, you can convert the expected cash flows on your Mexican project into US dollars taking into account the expected exchange rate movements.

If Nominal Interest Rates Are 5% in the United States