Let's solve the money market hedge step by step. **Given:** - Amount owed: €100,000 in 1 year - Spot rate: $1.50/€ - Forward rate: $1.25/€ - US interest rate: 3.00% per annum - Euro interest rate: 4.00% per annum We are to **calculate the total dollar cost using a money market hedge**. --- ### Step 1: Find the Present Value of the Euro Payment You owe **€100,000 in one year**. To hedge, you can **borrow dollars now, convert to euros, invest in euro, and pay off the euro loan in a year**. First, find how many euros you need to invest today at 4% to end up with €100,000 in one year: \[ PV = \frac{€100,000}{1 + 0.04} = \frac{€100,000}{1.04} = €96,153.85 \] --- ### Step 2: Convert Dollars to Buy Euros Today You need to buy **€96,153.85** at the **spot rate of $1.50/€**: \[ \text{Dollar amount to buy euros} = €96,153.85 \times \$1.50/€ = \$144,230.77 \] --- ### Step 3: Borrow Dollars Today Since you don't have the dollars today, you need to **borrow \$144,230.77** at the US interest rate of 3% per annum. --- ### Step 4: Calculate the Amount You Owe in One Year After 1 year, you pay back the dollar loan with interest: \[ \text{Loan repayment} = \$144,230.77 \times (1 + 0.03) = \$144,230.77 \times 1.03 = \$148,557.69 \] --- ### Step 5: Summary Table | Step | Amount | |-----------------------------------|-------------| | Euros to invest today | €96,153.85 | | Dollars needed today | $144,230.77 | | Dollar loan repayment in 1 year | $148,557.69 | | Euros received in 1 year | €100,000 | --- ### **Final Answer** > **The total dollar cost of this purchase using a money market hedge is $148,557.69.** --- #### **Explanation Summary** - You borrow \$144,230.77 at 3% interest. - Convert to €96,153.85 at $1.50/€, invest at 4% to reach €100,000 in 1 year. - In a year, pay back the dollar loan of $148,557.69 and use the €100,000 investment to pay the supplier. **Thus, your total dollar cost in one year is:** \[ \boxed{\$148,557.69} \] --- If you have any more questions about forward or options hedges for the same scenario, let me know!