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Amazon has a division in Mexico
Amazon has a division in Mexico. Amazon needs to borrow money for its Mexican division and has the choice of borrowing in Mexico or the US. The effective annual interest rate in the US is 5 percent and the interest rate in Mexico is 10 percent. The current exchange rate is 20 Mexican pesos per US dollar. If you believe that the US dollar will depreciate 10 percent against the Mexican peso over the next 6 months, where should Amazon borrow? For simplicity, assume that the company wants to borrow $150 dollars for 6 months.
Expert Solution
Borrowing in Mexico:
Given, exchange rate= 20 Pesos/Dollar
Money borrowed= 150*20= 3,000 Pesos
Effective Annual rate in Mexico= 10%
Therefore, equivalent semi annual rate= (1+10%)^(1/2)-1 = 4.88088%
Maturity value= 3000*(1+ 4.88088%) = 3146.43 Peso
Expected exchange rate after 6 months= 20 peso per 1.10 dollar (Due to appreciation of dollar by 10%)
Value in dollar= 3146.43*1.1/20= $173.05
Borrowing in US:
Amount borrowed= $150
Effective Annual Interest rate in US= 5%
Equivalent semi annual rate= (1+5%)^(1/2)-1 = 2.469508%
Maturity value= 150*(1+2.469508%) = $153.70
Therefore, Amazon shall borrow in US.
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