A US company borrows British pounds for 1 year at 10 percent. The pound depreciates from $1.50 to $1.20, or 20 percent, over the life of the loan. Interest on this loan is paid at maturity. The effective interest rate of the loan in US dollar terms is:
A negative effective interest rate implies that the US borrower actually paid fewer dollars in total loan repayment than the number of dollars borrowed. Such a result can arise if the British pound depreciates substantially over the life of the loan. As shown in example 14.3, however, the effective interest rate in dollar terms can be much higher than the quoted interest rate if the British pound appreciates substantially over the life of the loan.
Was this article helpful?