Problem
You are a U.S. investor trying to calculate the present value of a €9 million cash inflow that will occur one year in the future. The spot exchange rate is S=$1.208/€, and the forward rate is F=$1.219/€.
You estimate that the appropriate dollar discount rate for this cash flow is 7% and the appropriate euro discount rate is 6%.
I. What is the present value of the €9 million cash inflow computed by first discounting the euro and then converting it into dollars?
II. What is the present value of the €9 million cash inflow computed by first converting the cash flow into dollars and then discounting it?
III. What can you conclude about whether these markets are internationally integrated, based on your answers to (I) and (II)?