Assume the U.S. one-year interest rate is 8%, and the British one-year interest rate is 6%. The one-year forward rate of the pound is $1.97. The spot rate of the pound at the beginning of the year is $1.95. By the end of the year, the pound's spot rate is $2.05. Based on the information, what is the effective financing rate for a U.S. firm that takes out a one-year, uncovered British loan?
A)about 12.4%.
B)about 7.1%.
C)about 13.5%.
D)about 10.3%.
E)about 11.3%.

Question

Quizplus · Accepted Answer

$\%$ change in pound $= \frac { \$ 2.05 - \$ 1.95 } { \$ 1.95 } =$ about $5.1 \%$
$\text { Effective financing rate } = ( 1 + 6 \% ) ( 1 + 5.1 \% ) - 1 = 11.4 \%$