Computation: Suppose a US firm takes out a loan for €10 million from a German ba
ID: 1151122 • Letter: C
Question
Computation: Suppose a US firm takes out a loan for €10 million from a German bank. When it takes out the loan, the exchange rate is $1 US to € 1 Euro. It promises to pay back the loan, plus 10% interest in 1 year. It converts the loan to $US and earns a real rate of return of 11%. When it comes time to pay back the loan, the exchange rate is $1 US to € .8 Euro.
a) Calculate the amount the firm must pay back in Euros at the end of the year. Show your work.
b) Calculate the amount of interest the firm earns on this venture. Show your work.
c) Calculate profit/loss of the US firm based only on the information given? Show your work. (Hint, what is the revenue the firm makes? What amount does it have to pay the German bank?)
Explanation / Answer
a... Loan = € 10 million
Spot exchange rate , S0 = $1/€
Rate of interest , r = 10?
Time, t = 1year
Rate of reinvestment = 11?
Future rate of interest = $0.8/€
Converted € to $ at the spot exchange rate and realised
€10 mn × $1/€ = $10 million
Invested $10 mn at a rate of 11% for 1 year. Realized amount
$10 mn × e0.11×1 = $ 11.1628 mn
Converting $11.628 mn to € at a rate of $0.8/€
Amount = $11.1628/$0.8/€
= € 13.9535
b.Firm is required to pay an interest of 10% upon € 10 mn plus loan
After one year liability = €10mn ×e0.1×1 = €11.0518 mn
Amount to be paid = €11.0518 million
Amount of interest earned = $11.1728 mn -$10 mn
=$1.1728 mn
Amount of interest earned after paying loan =€13.9535 mn - €11.0518 mn = € 2.905 million
c.Profit or loss = €13.9535 mn - €11.0518 mn =€ 2.905 mn
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