Consider the Situation of Firm a and Firm B $$\begin{array} { l l l } & \$ & £ \\\text { A } & \$ 6 \% & £5 \% \\B & \$7 \% & £ 4\%\end{array}$$

question 28

Essay

Consider the situation of firm A and firm B.The current exchange rate is $2.00/£ Firm A is a U.S.MNC and wants to borrow £30 million for 2 years.Firm B is a British MNC and wants to borrow $60 million for 2 years.Their borrowing opportunities are as shown,both firms have AAA credit ratings.
$$\begin{array} { l l l } & \$ & £ \\\text { A } & \$ 6 \% & £5 \% \\B & \$7 \% & £ 4\%\end{array}$$ The IRP 1-year and 2-year forward exchange rates are $F _ { 1 }$ ($ ∣ £)= $\frac { \$ 2.00 \times ( 1.06 ) } { £ 1.00 \times ( 1.04 ) }$ = $\frac { \$ 2.0385 } { £ 1.00 }$ $F _ { 2 }$ ($ ∣ £)= $\frac { \$ 2.00 \times ( 1.06 ) ^ { 2 } } { £ 1.00 \times ( 1.04 ) ^ { 2 } }$ = $\frac { \$ 2.0777 } { £ 1.00 }$ USD pounds
$$\begin{array} { c c c c } \text { Bid } & \text { Ask } & \text { Bid } & \text { Ask } \\6\% & 6.1 \% & 4 \%& 4 .1\%\end{array}$$ Explain how firm A could use the forward exchange markets to redenominate a 2-year $60m 6 percent USD loan into a 2-year pound denominated loan.

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Definitions:

Dishonoured Note

A promissory note that has not been paid by the maker or acceptor when due, leading to a default.

Maturity Date

The specified date on a financial instrument when the principal amount must be repaid or when an investment reaches its full value and can be redeemed.

Negotiable Instrument

A document guaranteeing the payment of a specific amount of money, either on demand or at a set time, with the payer named on the document.

Past-Due Account

A past-due account is a financial account that has not been paid by the due date, often leading to penalties or interest charges.