Question Details

Mexican subsidiary needs a one-year loan of 10 million pesos 



1. IRP Application to Short-term Financing. Assume that the U.S. interest rate is 7 percent and the
euro- interest rate is 4 percent. Assume that the euro- forward rate has a premium of 4 percent.
Determine whether the following statement is true: “Interest rate parity does not hold; therefore,
U.S. firms could lock in a lower financing cost by borrowing euros and purchasing euros forward
for one year.” Explain your answer.


2. Break-even Financing. Orlando, Inc., is a U.S.-based MNC with a subsidiary in Mexico. Its
Mexican subsidiary needs a one-year loan of 10 million pesos for operating expenses. Since the
Mexican interest rate is 70 percent, Orlando is considering borrowing dollars, which it would
convert to pesos to cover the operating expenses. By how much would the dollar have to
appreciate against the peso to cause such a strategy to backfire? (The one-year U.S. interest rate is
9%.)




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