Suppose the CFO of a German corporation with surplus cash flow has 1 million Eur

Question

Suppose the CFO of a German corporation with surplus cash flow has 1 million Euros to invest. Suppose that interest rates on 1-year CD deposits in US banks are 2%, while rates on 1year CD deposits denominated in euros in German banks are currently 4.5%. Suppose further that the CFO expects that the (euro/$) exchange rate will increase from 1euro per $ to 1.1 euros per $ during the coming year. Should the CFO invest in CD's denominated in dollars or in euros? Show your work of estimation to substantiate your response as credible!

Explanation / Answer

Present Conversion rate:1 million euro = 1 million dollar

CD Deposits in US banks

Amount = (1,000,000)*(1.02) = $1,020,000

Conversion rate 1 yr from now: 1.1 euro = $1

Amount in euros = 1,020,000*1.1 = 1,122,000 euro

CD Deposits in Euro

Amount = (1,000,000)*(1.045) = 1,045,000 euro

Conversion rate 1 yar from now: 1.1 euro = $1

Amount in $ = 1,045,000/1.1 = $950,000

As can be seen as the amount after one year if invested in CDs denomination in dollars is higher, the CFo shall invest in dollars.

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