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International Finance

15. Suppose today's exchange rate is $0.62/Euro. The 6-month interest rates on dollars and Euro are 6% and 3%, respectively. The 6-month forward rate is $0.6185. A foreign exchange advisory service has predicted that the Euro will appreciate to $0.64 within six months.

a. How would you use forward contracts to profit in the above situation?

b. How would you use money market instruments (borrowing and lending) to profit?

c. Which alternatives (forward contracts or money market instruments) would you prefer? Why?

Solution Preview

a. How would you use forward contracts to profit in the above situation?

ANSWER. By buying Euro forward for six months and selling it in the spot market, you can lock in an expected profit of $0.0215 (0.64 - 0.6185) per Euro bought forward. This is a semiannual percentage return of ...

Solution Summary

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$2.19