Final answer:
The interest rate cost of the bond in USD, after considering the expected appreciation of the EUR from USD1.10 to USD1.2, is 9.09%.
Step-by-step explanation:
To calculate the interest rate cost of a bond in USD, given the parameters of a 4% borrowing rate in EUR, a current exchange rate of USD1.10/EUR, and an expected appreciation of the EUR to USD1.2/EUR, we'll need to consider the impact of exchange rate changes on the cost of the bond. First, the corporation will incur a 4% interest expense in EUR terms. However, if the EUR appreciates from USD1.10 to USD1.2 over the course of the year, it will cost more dollars to pay back the borrowed euros at the end of the year. Therefore, not only the interest cost but also the principal repayment will be affected by the exchange rate movement.
Let's assume the corporation borrows €1,000. After one year, it will owe €1,040 due to the 4% interest rate. At the beginning, €1,040 would have been worth USD1,144 (€1,040 x USD1.10/EUR). But if the EUR appreciates to USD1.2/EUR, the amount payable would now be USD1,248 (€1,040 x USD1.2/EUR). The interest rate cost in USD terms would thus be higher due to the appreciation of the EUR.
Calculating the effective interest rate in USD involves finding the percentage increase from the initial dollar equivalent of the borrowed amount to the final dollar equivalent at the appreciated exchange rate. This gives us the formula (USD1,248 - USD1,144) / USD1,144 = 0.0909 or 9.09%. Therefore, the interest rate cost of the bond in USD, considering the expected appreciation of the EUR, is 9.09%.