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Present Value of Cash Flows in Dollars and Euros

You are a U.S. investor who is trying to calculate the present value of a ?5 million cash inflow that will occur one year in the future. The spot exchange rate is S = $1.25/? and the forward rate is F1 = $1.215/?. You estimate that the appropriate dollar discount rate for this cash flow is 4% and the appropriate euro discount rate is 7%.
a. What is the present value of the ?5 million cash inflow computed by first
discounting the euro and then converting it into dollars?
b. What is the present value of the ?5 million cash inflow computed by first
converting the cash flow into dollars and then discounting?
c. What can you conclude about whether these markets are internationally
integrated, based on your answers to parts (a) and (b)?

Solution Preview

a. In this case we discount at the euro discount rate and then convert to $ using the spot exchange rate since the PV is af of now. The cash flow is at the end of 1 year. The PV of cash ...

Solution Summary

The solution explains how to calculate the present value of cash flows

$2.19