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International Finance

3. Gizmo, U.S.A. is investigating medium term financing of $10 million in order to build an addition to its factory in Toledo, Ohio. Gizmo's bank has suggested the following alternatives:

Type of loan Rate

3-year U.S. dollar loan 14
3-year Euro loan 8
3-year Swiss franc loan 4

a. What information does Gizmo require to decide among the three alternatives?

b. Suppose the factory will be built in Geneva, Switzerland, rather than Toledo. How does this affect your answer in part a?

Solution Preview

a. What information does Gizmo require to decide among the three alternatives?

ANSWER. It is useful to divide this problem into two issues: what is the expected cost and what is the risk of each alternative. Defining the terms "cost" and "risk" requires careful thought.

If we assume that (1) the international money markets are efficient and (2) the international Fisher effect holds (these are separate issues) then the expected cost of each loan is the same. If the market is anticipating that for the next three years the Euro and the Swiss franc will appreciate 6% and 10% annually, respectively, then the expected U.S. dollar cost of each loan is the same. If we are unwilling to make assumptions (1) and (2), then we need ...

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$2.19