Suppose today’s exchange rate is $1.35/€. The six-month interest rates on dollars and euros are 6% and 3%, respectively. The six-month forward rate is $1.3672. A foreign exchange advisory service has predicted that the euro will appreciate to $1.375 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?