Interest Rate Parity Application to Short-Term Financing Connecticut Co. plans to finance its U.S. operations. It can borrow euros on a short-term basis at a lower interest rate than if it borrowed dollars. If interest rate parity does not hold, what strategy should Connecticut Co. consider when it needs short-term financing? Assume that Connecticut Co. needs dollars. It borrows euros at a lower interest rate than the interest rate for dollars. If interest rate parity exists and if the forward rate of the euro is a reliable predictor of the future spot rate, what does this suggest about the feasibility of such a strategy? If Connecticut Co. expects the current spot rate to be a more reliable predictor of the future spot rate, what does this suggest about the feasibility of such a strategy?

FindFind

International Financial Management

14th Edition
Madura
Publisher: Cengage
ISBN: 9780357130698
FindFind

International Financial Management

14th Edition
Madura
Publisher: Cengage
ISBN: 9780357130698

Solutions

Chapter 20, Problem 7QA
Textbook Problem

Interest Rate Parity Application to Short-Term Financing Connecticut Co. plans to finance its U.S. operations. It can borrow euros on a short-term basis at a lower interest rate than if it borrowed dollars.

  1. If interest rate parity does not hold, what strategy should Connecticut Co. consider when it needs short-term financing?
  2. Assume that Connecticut Co. needs dollars. It borrows euros at a lower interest rate than the interest rate for dollars. If interest rate parity exists and if the forward rate of the euro is a reliable predictor of the future spot rate, what does this suggest about the feasibility of such a strategy?
  3. If Connecticut Co. expects the current spot rate to be a more reliable predictor of the future spot rate, what does this suggest about the feasibility of such a strategy?

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