Question

Suppose that the treasurer of Apple has an extra cash reserve of $200,000,000 to invest for six months. The six-month interest rate is 4 percent per annum in the United States and 3 percent per annum in France. Currently, the spot exchange rate is €1.00 per dollar and the six-month forward exchange rate is €0.98 per dollar. The treasurer of Apple does not wish to bear any exchange risk. Where should he/she invest to maximize the return?  

Answer 1

Sol:

Total cash reserves = $200,000,000

Annual interest rate in United States = 4%, Semiannual = 4 / 2 = 2%

Annual interest rate in France = 3%, Semiannual = 3 / 2 = 1.5%

Spot exchange rate = €1.00 per dollar

Six-month forward exchange rate = €0.98 per dollar.

We have to first compute the maturity value of $200,000,000 cash reserves invested in U.S:

Maturity value of investment in U.S = 200,000,000 * (1 + 2%) = $204,000,000

Now convert the cash reserves of $200,000,000 into euros and then invest the reserve money at France interest rate with the forward contract sold at euro maturity. So the maturity value in dollar will be as follows:

Maturity value of investment in France = (200,000,000 * 1.00) * (1 + 0.015) * (1 / 0.98)

Maturity value of investment in France = 200,000,000 * 1.015 * 1.0204 = $207,142,857.14

Therefore to maximize the return investment in France is most feasible, since the maturity value of investing in France taking into consideration the exchange hedging risk will be higher than investing in U.S