You are a U.S. investor who is trying to calculate the present value of a €5 million cash inflow that will occur 1 year in the future. The spot exchange rate is S = $1.25/€ and the forward rate is F1 = $1.215/€. You estimate that the appropriate dollar discount rate for this cash flow is 4% and the appropriate euro discount rate is 7%.
a. What is the present value of the €5 million cash inflow computed by first discounting the euro and then converting it into dollars?
b. What is the present value of the €5 million cash inflow computed by first converting the cash flow into dollars and then discounting?
c. What can you conclude about whether these markets are internationally integrated, based on your answers to parts (a) and (b)?
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