PPP and Cash Flows
Response to the following problem:
Boston Co. will receive 1 million euros in 1 year from selling exports. It did not hedge this future transaction. Boston believes that the future value of the euro will be determined by purchasing power parity (PPP). It expects that inflation in countries using the euro will be 12 percent next year, while inflation in the United States will be 7 percent next year. Today the spot rate of the euro is $1.46, and the 1-year forward rate is $1.50.
a. Estimate the amount of U.S. dollars that Boston will receive in 1 year when converting its euro receivables into U.S. dollars.
b. Today, the spot rate of the Hong Kong dollar is pegged at $.13. Boston believes that the Hong Kong dollar will remain pegged to the dollar for the next year. If Boston Co. decides to convert its 1 million euros into Hong Kong dollars instead of U.S. dollars at the end of 1 year, estimate the amount of Hong Kong dollars that Boston will receive in 1 year when converting its euro receivables into Hong Kong dollars.