Assume the U.S. one-year interest rate is 9%, while the Chilean one-year interest rate is 13%. If the Chilean peso ____ by ____%, a U.S.-based MNC would incur the same financing cost in dollars versus Chilean pesos over a one year period.
A) depreciates; 3.54
B) appreciates; 3.54
C) depreciates; 3.67
D) appreciates; 3.67

Question

Quizplus · Accepted Answer

To find out the percentage change needed in the Chilean peso, we can use the interest rate parity formula: 
((1 + US interest rate)/(1 + Chilean interest rate)) - 1
((1 + 0.09)/(1 + 0.13)) - 1 = -0.039
This means that the Chilean peso would need to depreciate by 3.9% to offset the higher interest rate. However, none of the answer choices match this percentage exactly, so we need to choose the closest one. 
Choice A, a depreciation of 3.54%, is the closest to the calculated 3.9%. Therefore, if the Chilean peso depreciates by 3.54%, a U.S.-based MNC would incur the same financing cost in dollars versus Chilean pesos over a one year period.