Introduction to Finance

3.
What is the time frame? 
In this example, the treasurer has excess funds to invest for the 
next year. 
4.
What is the forward rate? 
In this example, the forward rate is €0.87/$ (or $1.1494/€).
What if today’s one-year forward rate was €0.93/$ (or $1.07527/€)? In this case, the 
treasurer would decide to keep the funds invested in the United States. We know that after one 
year his $100,000 will grow to $105,000 if he does so. If he invests in Europe, the $100,000 is 
converted to €90,000 at today’s spot rate and invested at 7 percent. After one year, the treas-
urer will have €96,300. Thus far, this is the same as the prior example—but now we apply the 
forward rate of €0.93/$ (or $1.07527/€). 
Converting the euros back to dollars, the treasurer will have €96,300 × $1.07527/€ = 
$103,548.50. In this case, the decision to invest at the United States interest rate of 5 percent 
results in a greater amount, $105,000, after one year than investing in Europe even though 
Europe has the higher interest rate. Forward rates matter!
6
A confusing point to some students is choosing which number to multiply by—should we multiply the €96,300 
by €0.87/$ or $1.1494/€? Here, since we want to compare dollars invested in the U.S. with dollars after invest-
ing overseas, we want our fi nal answer to be in dollar units. Therefore, we want to calculate €96,300 × 
$1.1494/€ = $110,687.22. Why? We have euros in the numerator of €96,300 and euros in the denominator of 
$1.1494/€; they will cancel out leaving the units of the fi nal answer to be U.S. dollars.
If we erroneously multiply €96,300 by €0.87/$, we have a fi nal answer with units of €2/$. Since those units do 
not make economic sense, we know that the correct calculation is €96,300 × $1.1494/€ = $110,687.22.

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