I am working on the following probelm: I know the answer to part a, which is tha

Question

I am working on the following probelm: I know the answer to part a, which is that he should buy more euros. I am confused on why he should buy more euros when the euro is gaining value against the dollar. Can someone please ellaborate more on that. Thanks.

Christoph Hoffeman trades currency for Blade Capital of Geneva. Christoph has $10 million to begin with, and he must state allprofits at the end of any speculation in U.S. dollars. The spot rate on the euro is $1.3358/€, while the 30-day forward rate is$1.3350/€.

a.If Christoph believes the euro will continue to rise in value against the U.S. dollar, so that he expects the spot rate to be$1.3600/€ at the end of 30 days, what should he do?

Explanation / Answer

He should buy more of Euro because Euro is gaining value which is a prediction that it will go on increasing .In such conditions,the buyer can buy Euro and sell it in the spot market to make earnings in terms of dollars when the Euro agains further value in future.

If he expects spot rate to have risen $1.3600/Euro at the end of 30 days ,it means spot rate will rise further in future.The buyer can buy more of Euro and sell it at a higher price in future.

Why a currency gains value against other

If companies in the United States are importing large quantities of products made in Europe, they will need to exchange their US Dollars for Euros to pay for the products.

When this is done in very large quantity over a short period of time, it raises the demand for Euros and the value of the Euro versus US Dollar increases. This happens because dollars are being sold on the open market, while Euros are being bought.

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