Assume the U.S. interest rate is 7.5%, the New Zealand interest rate is 6.5%, the spot rate of the NZ$ is $.52, and the one-year forward rate of the NZ$ is $.50. At the end of the year, the spot rate is $.48. Based on this information, what is the effective financing rate for a U.S. firm that takes out a one-year, uncovered NZ$ loan?

Question

Quizplus · Accepted Answer

The effective financing rate is the interest rate that the U.S. firm would have to pay if it borrowed in the U.S. and then converted the proceeds into NZ$ to invest in New Zealand. The effective financing rate is calculated as follows:Effective financing rate = (1 + U.S. interest rate) * (1 + New Zealand interest rate) - 1In this case, the U.S. interest rate is 7.5% and the New Zealand interest rate is 6.5%, so the effective financing rate is:Effective financing rate = (1 + 0.075) * (1 + 0.065) - 1 = 0.147 or 14.7%