GBA Company wishes to raise $5,000,000 with debt financing. The funds will be repaid with in- terest in 1 year. The treasurer of GBA Company is considering three sources:
i. Borrow USD from Citibank at 1.50%
ii. Borrow EUR from Deutsche Bank at 3.00%
iii. Borrow GBP from Barclays at 4.00%
If the company borrows in euros or British pounds, it will not cover the foreign exchange risk; that is, it will change foreign currency for dollars at today's spot rate and buy foreign currency back 1 year later at the spot rate prevailing then. The GBA Company has no operations in Europe.
A representative of GBA contacts a local aca- demic to provide projections of the spot rates 1 year in the future. The academic comes up with the following table:
Projected Rate 1 Currency Spot Rate Year in the Future
USD> GBP 1.50 1.55
USD> EUR 0.95 0.85
a. What is the expected interest rate cost for the loans in EUR and GBP?
b. What are the projected USD > GBP rate and USD> EUR rate for which the expected interest costs would be the same for the three loans?
c. Should the country borrow in the currency with the lowest interest rate cost? Why or why not? Would your answer change if GBA did generate cash flows in the United Kingdom and continental Europe?