Arlington Corp is considering borrowing 2,500,000 euros from a French bank to pa

Question

Arlington Corp is considering borrowing 2,500,000 euros from a French bank to partially finance an investment. The loan will be made when the spot rate is $1.34. They will repay the French bank 3,802,650 euros when the loan is repaid in 5 years. This is a discounted loan-there will be no other interest or principal payments.
i) Calculate the loan's nominal interest rate (the rate from the point of view of the lender).
ii) Assume the spot rate for euros is $1.45 when the loan is repaid. What was the interest rate on the loan after adjusting for the change in interest rates?

Explanation / Answer

Let Interest rate by lender be k. So, 3802650 = 2500000*(1+k)^5 K = 0.0875 = 8.75% (ANSWER) Dollars received @1,34 $/Euro,(at t = 0) = 1.34*2500000 = 3350000 ($) Dollars paid at repayment @ 1.45$/Euro (at t =5) = 1.45*3802650 = 5513842.5 ($) Let Interest rate in dollar terms be r. So, 5513842.5 = 3350000(1+r)^5 r = 0.1048 = 10.48% (after taking exchange variations) into account) (ANSWER)

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