Pittsburgh Co. plans to invest its excess cash in Mexican pesos for one year.
Pittsburgh Co. plans to invest its excess cash in Mexican pesos for one year. The oneyear Mexican interest rate is 19%. The probability of the pesos percentage change
in value during the next year is shown below:
Possible Rate of Change
in the Mexican Peso Over Probability of
the Life of the Investment Occurrence
What is the expected value of the effective yield based on this information? Given that the U.S. interest rate for one year is 7%, what is the probability that a
oneyear investment in pesos will generate a lower effective yield than could be generated if Pittsburgh Co. simply invested domestically?
Should Interest Rate Parity Prevent MNCs From Investing in Foreign Currencies?
POINT: Yes. Currencies with high interest rates have large forward discounts according to interest rate parity. To the extent that the forward rate is a reasonable
forecast of the future spot rate, investing in a foreign country is not feasible.
COUNTER-POINT: No. Even if interest rate parity holds, MNCs should still consider investing in a foreign currency. The key is their expectations of the future spot
rate. If their expectations of the future spot rate are higher than the forward rate, the MNC would benefit from investing in a foreign currency.
WHO IS CORRECT? Use the Internet to learn more about this issue. Which argument do you support? Offer your own opinion on this issue.
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