The euro exchange rate is $1.25/euro

The euro exchange rate is $1.25/euro. The continuously compounded dollar interest rate it 5% and the continuously compounded euro in- terest rate is 4%. Suppose that you borrow euros and lend dollars for 1 year. At what exchange rate will you break even on this position?

Expert Solution

1) Borrow Euro 1 for 1 year

2) Buy $1.25 using that Euro 1

3) Lend $1.25 for 1 year

4) Amount realized after 1 year with interest = 1.25+(e^0.05) = 1.25*1.0513(from table) = $1.314125

5) Euros needed to be repaid with interest = 1+(e^0.04) = 1*1.0408(from table) = Euros 1.0408

Breakeven Exchange Rate = 1.314125/1.0408 = $1.2626/Euro

jeff jeffy answered 2 years ago

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