A firm forecasts the euro's value as follows for the next year:

The annual interest rate on euro is 7%. The expected value of the effective financing rate from a U.S.firm's perspective is about:

Question

A firm forecasts the euro's value as follows for the next year:

The annual interest rate on euro is 7%.  The expected value of the effective financing rate from a U.S.firm's perspective is about:

Quizplus · Accepted Answer

To calculate the effective financing rate from a US firm's perspective, we need to determine the expected return from investing in euros and then convert that return into U.S. dollars using the expected exchange rate. 
The expected return from investing in euros can be calculated as the sum of the expected spot rate appreciation and the interest rate differential. 
Expected return = spot rate appreciation + interest rate differential
= (1.15-1)/1 + 0.07
= 0.23 + 0.07
= 0.30 or 30%
Next, we need to convert this return into U.S. dollars using the expected exchange rate. 
Expected effective financing rate = (1 + euro return) * (1/expected exchange rate) - 1
= (1.30) * (1/1.18) - 1
= 0.10 or 10.959% (rounded to the nearest thousandth)
Therefore, the expected value of the effective financing rate from a U.S. firm's perspective is about 10.959%.

A Firm Forecasts the Euro's Value as Follows for the Next