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?

Solutions

Expert Solution

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

cost of paying today = €100,000 *$1.3/5€ =135,000 $

so deposit 135,000 $ at 3% p.a for 6 months

interest recieved after 6 months = pincipal *(1+r)ⁿ

=135,000 $ *1.5%

=2025

forward rate is $1.30/€

payable in 6 months

gross cost of payable in 6 months= €100,000 *$1.30/€ =$130,000

less interest on deposit in ny city = $ 2,025

net payable =$130,000 -$ 2,025= $127,975

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

future value = €100,000

r= 4 p.a for 6 months is 2%

present value = future value / (1+R)ⁿ

=€100,000/1.02

=€98,039

converting € to $ using spot rate is

=€98,039*$1.35/€

=$132,353

we have payable we chose lower amount of payable ie $127,975

option a is preferable

give me positive rating , let me know if you need any information.

jeff jeffy answered 1 year ago

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