Read the scenario presented in Chapter 6 Problem #2 (at the end of the chapter):

Question

Read the scenario presented in Chapter 6 Problem #2 (at the end of the chapter): While you were visiting London, you purchased a Jaguar for £35,000, payable in three months. You have enough cash at your bank in New York City, which pays 0.35 percent interest per month, compounding monthly, to pay for the car. Currently, the spot exchange rate is $1.45/£ and the three-month forward exchange rate is $1.40/£. In London, the money market interest rate is 2.0 percent for a three-month investment. There are two alternative ways of paying for your Jaguar. a. Keep the funds at your bank in the United States and buy £35,000 forward. b. Buy a certain pound amount spot today and invest the amount in the U.K. for three months so that the maturity value becomes equal to £35,000. Analyze the alternatives presented and make a recommendation on purchasing the Jaguar. Be sure to provide support for your recommendation – why do you prefer the stated alternative? What are the advantages of the alternative that you have selectstings.

Explanation / Answer

B. Buy a certain amount pound amount spot today and invest the amount in the U.K. for three months so that maturity value becomes equal to 35,000 pounds.

B. is recommended for purchasing Jaguar.

Since spot exchange rate is $1.45 per pound and three month forward exchange rate is $1.40 per pound

so in three months the exchnage rate may drasctically incraese or decrease. So, its better to invest in pound to be secured and avoid any loss.

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