(hedging exchange rate risk) The current level of real estate prices in Moscow seem to be on a reasonable level now and you consider that this is just the right time to step into the market. You have noticed a nice apartment in the Leninsky Prospekt close to the city centre. The price for the apartment is $1.46 million. However, due to tax reasons you could buy that apartment only after 6 months. Currently you have sufficient funds deposited in a bank in Cypros (in euros). The annual yield on a bank deposit is 2.8%. Another option would be to convert a certain amount into dollars and deposit these funds into another bank with the annual yield of 1.6%. The spot exchange rate is 1.0606 EUR/USD (see the quote conventions from the lecture slides) and the 6m forward rate is quoted with discount equal to -84 basis points.
So, you have two options of how to pay for the apartment:
- Buy a forward contract for buying dollars against euros in six months (and continue to deposit euros)
- Invest enough dollars for dollar deposit already today.
Questions:
1) Try to show with calculations, which option has the lowest present value cost for you in euros?
2) Compute the correct forward rate implied by the interest rates