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Suppose that California Co., a U.S. based MNC, seeks to capitalize a difference in interest...

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Accounting

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Suppose that California Co., a U.S. based MNC, seeks to capitalize a difference in interest rates between euros and British pounds via the use of a carry trade. In particular, after 1 month, funds invested in euros will yield a 0.50% percent return, while funds invested in pounds will yield a return of 2.00% percent. Currently the spot rate of the British pound is $1.00 while the spot rate of the euro is $0.80. In other words, the pound is worth 1.25 euros. California Co. expects these spot rates to remain constant over the next month. change. Suppose that the euro appreciates over the course of the month, such that the cross exchange rate is now 0.78125 eurnes the spot rate for the pound remains constant at $1.00 per pound Under this new cross exchange rate of 0.78125, the 502,500 euros that California Co. needs to repay is equivalent to pounds. Thus, after repaying the loan, California Co. will have pounds from the 612,000 pounds they received from the initial investments. These pounds are equivalent to $31,200.00, and represents a profit of $ over the initial $200,000 that California Co. used from their own funds

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