You have the following information about rates in London for Eurocurrency loans of one-year duration, the exchange rate between the USD and euros, the currency in which you want financing, and the level of financing required:
- Eurodollar rates 2.15%
- Euroeuro rates 3.75%
- Exchange rate USD 1 = EUR 0.7035
- The volatility (standard deviation) of the above exchange rate is 15.45% p.a.
- You require a total of Euro 250,000,000 to fund capital investments, which is to be repaid at maturity of the loan.
(a) Discuss the pros and cons of financing in unhedged Eurodollars instead of via Euroeuros. As you do this you must give consideration to the foreign exchange risks associated with financing in Eurodollars.
(b) Provide a simple numerical example demonstrating the potential risk from financing in Eurodollars based on the above information.