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While you were visiting Frankfurt, you purchased a BMW for EUR 50,000, payable in three months. You have enough cash in USD at your bank in New York City, which pays 0.35% interest per month, compounding monthly, to pay for the car. Currently, the spot exchange rate is USD/EUR 1.35 and the three-month forward exchange rate is USD/EUR 1.30. In Frankfurt, the money market interest rate is 2% for a three-month investment. There are two alternative ways of paying for your BMW.

(a) Keep the funds at your bank in the United States and buy EUR 50,000 forward.

(b) Buy a certain euro amount spot today and invest the amount in Germany for three months so that the maturity value becomes equal to EUR 50,000.

Evaluate each payment method. Which method would you prefer? Why?

Reference no: EM133069984

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