Question

Euromarket investment and fund raising   A​ U.S.-based multinational company has two​ subsidiaries, one in Mexico​ (local currency, Mexican​ peso, MP) and one in Japan​ (local currency,​ yen, ¥). Forecasts of business operations indicate the following​ short-term financing position for each subsidiary​ (in equivalent U.S.​ dollars):

​Mexico: $85 million excess cash to be invested​ (lent)

​Japan: $70 million funds to be raised​ (borrowed)

The management gathered the following​ data:

Spot exchange rates		MP11.56/US$	¥108.57/US$
Forecast percent change		-2.98%	+1.54%
Interest rates
Nominal
Euromarket	4.02%	6.24%	2.02%
Domestic	3.73%	5.89%	2.17%

a) Determine the effective interest rates for all three currencies in both the Euromarket and the domestic​ market;

b) Then indicate where the funds should be invested and raised.  

​(​Note: Assume that because of local​ regulations, a subsidiary is not permitted to use the domestic market of any other​ subsidiary.)

Answer 1

Effective rate of return will be calculated by adding/subracting the nominal interest rate depending upon the appreciation or depreciation in the forecast percentage change and adding or subracting the nominal rate with the forecast percentage change.

E=N+F+(N*F)

E = Effective interest rate

N = Nominal interest rate

F = Forecast percentage change

Item	US $	MP	¥
Spot Exchange Rates		MP 11.56/US $	¥ 108.57/US $
Forecast percent change		-2.98%	1.54%
Interest Rates
Nominal:
Euro Market	4.02%	6.24%	2.02%
Domestic	3.73%	5.89%	2.17%
Effective:
Euro Market	4.02%	3.074%	3.591%
Domestic	3.73%	2.734%	3.743%

Notes:

Effective rates in Euro Market

In MP

E=N+F+(N*F)

=((6.24%+(-2.98%))+(6.24%*(-2.98%))

0.03074048

3.074%

In ¥

E=N+F+(N*F)

=((2.02%+(1.54%))+(2.02%*(1.54%))

0.03591108

3.591%

Effective rates in Domestic Markets

In MP

E=N+F+(N*F)

=((5.89%+(-2.98%))+(5.89%*(-2.98%))

0.02734478

2.734%

In ¥

E=N+F+(N*F)

=((2.17%+(1.54%))+(2.17%*(1.54%))

0.03743418

3.743%

Mexico: $85 million excess cash to be invested in US as its the highest effective rate of 4.02% in Euro market.

Japan: $70 million funds to be raised​ (borrowed) in Mexico as its the lowest effective rate of 3.074% in Euro market.