Question

Katy, Inc, a U. S. -based MNC, obtains a one-year loan of 2,000,000 British pounds at a nominal interest rate of 8 percent. At the time the loan is extended, the spot rate of the pound is $1.33. If the spot rate of the pound in one year is $1.23   (1) Has the pound appreciated or depreciated against the dollar?   (2) Calculate the dollar amount initially obtained from the loan.   (3) Calculate the dollar amount Katy needs to repay the loan.

Please show how answer is derived.

Answer 1

1). Spot rate of the pound (GBP) has gone from $1.33 to $1.23 in one year. So, after one year, the dollar amount in exchange for a GBP has decreased. Hence, the GBP has depreciated.

2). 1 GBP = $1.33

Therefore, 2 million GBP = $(2,000,000*1.33) = $2,660,000

The dollar amount initially obtained from the loan is $2,660,000

3). Total amount to be repaid after one year = princiapl*(1+r)

where principal = 2,000,000 GBP and r = 8%

Total amount = 2,000,000*(1+8%) = 2,160,000 GBP

Spot rate is 1 GBP = $1.23

Thus, dollar amount of 2,160,000 GBP = $(2,160,000*1.23) = $2,656,800

Katy has to repay $2,656,00.