Maple Corporation is a US company and is considering borrowing £10,000,000 from a syndicate of British Banks to make improvements to its manufacturing plant in the US. The current exchange rate is $1.55/£, and the interest rate on this loan is 7.00% per year. The loan will need to be repaid at the end of two years.
a) Suppose that the British pound is expected to appreciate against the dollar at 4% per annum. Compute the effective cost of the loan.
b) Consider an alternative scenario. Suppose that the pound is expected to depreciate against the dollar at 1.5% per annum. Compute the effective cost of the loan.
c) Consider yet another scenario. Suppose that the expected annual inflation is 3% in the US and 0.5% in the UK. Suppose that the pound-dollar exchange rate movement is in accordance with relative purchasing power parity. Compute the effective cost of the loan.