A U.S.-based company plans to invest in a new project in Europe that will require EUR 10
Question:
A U.S.-based company plans to invest in a new project in Europe that will require EUR 10 million in 1 year. The company can borrow funds in the U.S. at a cost of 4% per annum and can invest its excess cash in a U.S. money market fund that earns 2% per annum. The current spot exchange rate is USD/EUR 1.20, and the 1-year forward exchange rate is USD/EUR 1.22. The company wants to hedge its currency risk by entering into a forward contract with a notional amount of EUR 10 million and a 1-year maturity. Assume that the company can borrow and lend at the same rate.
a) Calculate the cost of borrowing and investing in the U.S. for the company.
b) Calculate the fair value of the forward contract.
(You may assume a 360-day year for interest rate calculations.)
Expert Answer:
The detailed answer for the above question is provided below a The cost of borrowi... View the full answer
