Suppose the euro is expected to appreciate by 4% annually against the dollar.If a company can borrow dollars at 9.3%,what is the highest interest rate it should be willing to pay to borrow euro,assuming it is trying to minimize its expected financing cost?

Question

Quizplus · Accepted Answer

The company should be willing to pay an interest rate on euros that, when adjusted for the expected appreciation of the euro, is equal to or less than the dollar interest rate. The effective cost of borrowing euros is the euro interest rate plus the expected appreciation rate. Therefore, the highest euro interest rate the company should be willing to pay is 9.3% - 4% = 5.3%. The closest option is 5.1%.

Suppose the Euro Is Expected to Appreciate by 4% Annually