Spain Airlines is a Spanish based firm that needs $210,400. It has no business in England but is considering one year financing with British pounds, because the annual interest rate would be 5 percent versus 9 percent in Spain.
Assume that interest rate parity exists. Assume that Spain Airlines does not cover its exposure and expects that the British pound will appreciate by 9 percent, 5 percent, or 3 percent, and with an equal probability of each.
Use this information to determine the probability distribution of the effective financing rate.
What is the probability of financing with the British pound will be less expensive. Show all work and answer all questions.