(hedging exhange rate risk) The current level of real estate prices in Moscow seem to be on reasonable level and you consider that this is just the right time to step into market. You have noticed noce apartment in the Leninsky Prospect close to the city centre. The price of the apartment is 1,46€ million. Howeve, due to tax reasons could buy that apartment only after 6 months. Currently you have sufficient funds deposited in the bank in Cyprus (in euros). The annual yield on bank deposit is 2,8%. Another option would be to convert a certain amount into dollars and deposit these funds in another bank with the annual yield of 1,6%. The spot exchange rate is 1,0606 EUR/USD 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:

a) Buy a forward contract for buying dollars against euros in six months ( and continue to deposit euros)

b) 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 foward rate implied by the interest rates