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In: Finance

While you were visiting Munich, you purchased a Range Rover for €100,000, payable in six months....

While you were visiting Munich, you purchased a Range Rover for €100,000, payable in six months. You have enough cash in US dollars at your bank in NY City, which pays 3% interest for six months, to pay for the car. Currently, the spot exchange rate is $1.35/€ and the six-month forward exchange rate is $1.30/€. In Munich, the money market interest rate is 4% for six months. There are two alternative ways of paying for your Range Rover.

a. Keep the funds at your bank in the US and buy €100,000 forward.

b. Buy a certain amount of € spot today and invest the amount in Germany for six months so that the maturity value becomes equal to €100,000. Evaluate each payment method in terms of $ cost. Which method would you prefer? Why?

Expert Solution

The Range Rover price is €100,000, payable in six months.

Spot Rate: 1 € = 1.35 $

6 months Forward Rate: 1 € = 1.30 $

Interest Rate on Investment in Munich is 4 % for 6 months

Interest Rate on Investment in NY City is 3 % for 6 months

Option (a): Keep the funds at your bank in the US and buy €100,000 forward.

Here bank in NY City Pays 3% interest for 6 months

Total Payment to be made in dollar after 6 months = 100,000 * 1.30

= $ 130000

Amount of dollar required as on today:

= 130000/ (1+i)

i= 3% rate of interest for 6 months

= 130000/(1.03)

= $ 126213.60

Therefore in option (a), there is requirement of $ 126213.60 to repay €100,000 in six months.

Option (b) : Buy a certain amount of € spot today and invest the amount in Germany for six months so that the maturity value becomes equal to €100,000

As interest rate in Munich is 4% for 6 months, amount of € required to repay €100,000 is as follow:

= 100000/(1+i)

i= 4% rate of interest for 6 months

= 100000/1.04

= € 96153.85

Amount of $ Required to buy € 96153.85

Spot Rate is 1 € = 1.35 $

Therefore, $ required = 96153.85*1.35= $ 129807.70

COMPARISON
Option	Outflow of $

(a)	126213.6
(b)	129807.7

Therefore Option (a) should be preferred.

jeff jeffy answered 1 year ago

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While you were visiting Munich, you purchased a Range Rover for €100,000, payable in six months....

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