When a U.S. firm borrows a foreign currency and has no offsetting position in this currency, it will incur an effective financing rate that is always above the ____ if the currency ____.
A) foreign currency's interest rate; appreciates
B) foreign currency's interest rate; depreciates
C) domestic interest rate; depreciates
D) domestic interest rate; appreciates

Question

Quizplus · Accepted Answer

If a U.S. firm borrows a foreign currency and has no offsetting position in this currency, it will incur an effective financing rate that is always above the foreign currency's interest rate if the currency appreciates. This is because the U.S. firm must convert the foreign currency back to dollars to repay the loan, and if the foreign currency has appreciated, this conversion will yield fewer dollars than the firm borrowed. Thus, the effective financing rate will be higher to compensate for the currency risk.

When a US Firm Borrows a Foreign Currency and Has No Offsetting