Question

You plan to visit Paris in three months to attend an international business conference. You expect to incur the total cost of €6,000 for lodging, meals and transportation during your stay. As of today, the spot exchange rate is ($0.80/€) . Calculate the future dollar cost of meeting this €6,000 obligation if you decide to hedge using a forward contract. Assume no arbitrage and that the three-month interest rate is 8 percent per annum in the United States and 4 percent per annum in Paris.

Answer 1

Future rate = Spot price x (1+Rate in US x 3/12) / (1+Rate in Paris x 3/12)

Future rate = 0.8 x (1+8% x 3/12) / (1+4% x 3/12)

Future rate = $0.807921 / €

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Total USD required after three months = 6000 x 0.807921

Total USD required after three months = $ 4,847.53

Hence, Future dollar cost is $4,847.53

(USD should become weak as it has high interest rate than in Euro zone, and it was $0.8 against 1 Euro earlier and after three months it became 0.8921 against 1 Euro)