Danielle GardnerDonna Zviely

Garrett McCulloch

Relative interest rates: ◦ Higher short term and long term rates in Europe than most other major currencies

Expected to attract foreign investment Dollar depreciates and Euro appreciates

Safe Haven Effect:◦ will strengthen Euro if investment flees from US to an alternate stable currency

Political/country risk: ◦ low political risk and country risk in the euro zone.

Carry Trade Strategies: ◦ speculators buy high interest currencies and sell currencies with low interest rates, thus

investors may purchase the Euro which has a higher interest rate than most, creating upward pressure on the currency and increase demand for the Euro

Unemployment is 9.2% in Europe, while 9.1 % in US Current Account in EUR is -25; US Current-account deficit decreased $53.4

billion to $101.5 billion in Q1 2009 Growth rate in EUR is -4.8% while Q1 2009 -5.5%

◦ Slowing rate of contraction In conclusion, the 3-month and 6-month spot rates will increase slightly against

the USD. We predict a rate of $1.42 for 3-month spot, and $1.44 for the 6-month spot rate.

http://www.usatoday.com/money/economy/2009-05-07-slow-us-economic-growth_N.htmwww.bloomberg.com

Assume: Spot EUR/USD: 1.4096 (as of June 26, 2009) Forecasted EUR rate of inflation for the next 12

months: 1.6% Forecasted US rate of inflation for the next 12

months: 1.3% Anticipated inflation rate differential = .3%PPP Spot EUR/USD Forecast: 1 year change in EUR: 1.4096 x 0.003 = 0.0042 3 month spot EUR: 1.4096 - 0.0042/4 = 1.4086 6 month spot EUR: 1.4096 - 0.0042/2 = 1.4075

http://forecasts.org/inflation.htmhttp://www.eui.eu/RSCAS/Research/EFN/EFN2009_spring.pdf

Assume: Spot EUR/USD = $1.4096 Current 3 month ECB rate = 0.596% Current 6 month ECB rate = 0.601% Current 3 month US Govt Bond rate = 0.15% Current 6 month US Govt Bond rate = 0.09% Differential 3 month = 0.596 – 0.15 = 0.446% Differential 6 month = 0.601 – 0.09 = 0.511% Spot rate x differential = 3 month change = 1.4096 x

0.00446 = 0.0063 Spot rate x differential = 6 month change = 1.4096 x

0.00511 = 0.0072IFE Spot EUR/USD: 3 month Spot EUR = 1.4096 – 0.0063 = 1.4033 6 month Spot EUR = 1.4096 – 0.0072 = 1.4024

http://www.ecb.int/stats/money/yc/html/index.en.html#datahttp://www.moneycafe.com/markets/interestrates.htm?qm_target_page=Rates

June 26 Spot = 1.4096

3 month spot

% change 6 month spot

% change

Asset Choice

$1.42 0.74% $1.44 2.16%

PPP $1.4086 -0.07% $1.4075 -0.15%

IFE $1.4033 -0.45% $1.4024 -0.51%

Our Choice:For both the 3-month and 6-month rates, we will choose the PPP model. These rates are neither the highest nor lowest, so we are being conservative with the middle selection

MNC open short: 3-month spot rate with the PPP model is $1.4086. 6-month = 1.4075.

This MNC is paying debt off in euro or making a euro denominated purchase, so they should not hedge with a futures contract because dollar-equivalent-costs will become lower in the future.  

The euro is depreciating against the dollar from $1.4096 to $1.4086 so a hedge would be detrimental to the financial value of the American based MNC. The same holds for the 6-month spot rate, because the euro will further depreciate against the dollar according to the PPP model that we have chosen.  

MNC open long: 3-month spot rate with the PPP model is $1.4086. 6-month = 1.4075.

This MNC is receiving euro, most likely from conducting business in the euro zone, so we will advise them to lock in a forward rate now, to assure a higher USD-equivalent-value than would be attained without the contract.

Since the euro will depreciate against the USD, the firm receiving euro will gain higher cash flows by locking in a forward contract with the current exchange rate of $1.4096. The euro is not expected to depreciate enough to use an options contract and pay the premium.

Euro Bond rates