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The real estate investor is considering adding additional studio apartments currently under construction to its investment portfolio. The total value of the six apartments to be purchased is 1.4 million euros. The apartments are booked, but the purchase price must be paid only after 9 months. At the moment, the investor has a sufficient amount deposited in the Cayman Islands to finance the purchase, but it is in US dollars. The annual bank deposit interest rate on the dollar deposit is 2.7%. Another option would be to immediately convert a certain amount into euros and deposit it in a Latvian bank, which offers 1.6% annual interest. The current exchange rate is EUR 1.2120 and the 9-month forward rate is currently quoted at a premium of +60 basis points.
There are thus two ways to mitigate currency risk and finance the purchase:
a) Enter into a 9-month forward contract to purchase euros against dollars and continue to deposit dollars
b) Terminate the deposit agreement and convert dollars into euros and deposit euros in a Latvian bank
Question:
• Indicate with calculations which option has the lower present value of the purchase price in dollars?
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