Basic Finance Questions

  1. Gomez Electronics needs to arrange financing for its expansion program. Bank A offers to lend Gomez the required funds on a loan in which interest must be paid at the end of each month, and the stated nominal rate is 12.00% per year. Bank B offers to lend Gomez the required funds on a loan in which interest is continuously compounded and the stated nominal rate is 11.95% per year. Bank C offers to lend Gomez the required funds on a loan in which interest must be paid semi-annually, and the stated nominal rate is 12.10% per year.

Make sure that you show or explain all calculations. Briefly explain your choice.

From which of the 3 banks should Gomez obtain financing?

 

  1. The interest rates in Canada and the United States are 6% and 5% per annum, respectively, with continuous compounding. The spot price of the Canadian dollar is $0.8000. The forward price for a contract deliverable in one year is $0.7900.

Does interest rate parity exist? If it does exist, then show why it exists. If interest rate parity does not exist, then show whether covered interest arbitrage is possible for Canadians or Americans. If covered interest arbitrage is possible, what is the annual rate of return with continuous compounding?

Make sure that you show or explain all calculations. Make sure you answer all questions above.

Hint: Covered interest arbitrage exists for Canadians, if a Canadian makes more than 6% (continuous compounding) from the following: selling Canadian dollars in the spot market, depositing US dollars in a US bank for one year, and buying Canadian dollars forward. Covered interest arbitrage exists for Americans, if an American makes more than 5% (continuous compounding) from the following: buying Canadian dollars in the spot market, depositing Canadian dollars in a Canadian bank for one year, and selling Canadian dollars forward.