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 calculate the equal financing cost in dollars, we need to use the interest rate parity formula:

(1 + US interest rate) / (1 + Chilean interest rate) = (1 + % change in USD/CLP exchange rate)

Substituting the given values, we get:

(1 + 0.09) / (1 + 0.13) = (1 + % change in USD/CLP exchange rate)

Solving for % change in USD/CLP exchange rate:

% change in USD/CLP exchange rate = -3.54%

This means that if the Chilean peso depreciates by 3.54% against the US dollar, a US-based MNC would incur the same financing cost in dollars versus Chilean pesos over a one year period. Therefore, the correct choice is A.