A firm in the U.S. has ordered a piece of equipment from a firm in Mexico. The piece of equipment sells for 78,500 pesos and the firm in the U.S. has been given a bill for that amount. The firm in the U.S. must pay for the equipment in six months and the firm has agreed to pay in pesos. The current spot rate is 26 pesos for one dollar. The six month interest rate in the U.S. is equal to 4% and the six month interest rate in Mexico is equal to 7%. A forward contract that comes due in six months has a forward rate of 28.5 pesos for a dollar. The firm in the U.S. wants to determine whether it should hold the funds it will need to pay the bill in the U.S. bank or whether it should convert dollars into pesos and hold the pesos in a Mexican bank for six months.

• In making the choice as to where to hold the funds, are calculations necessary? Or do you know the result prior to doing any calculations? Explain.
• Calculate how many dollars the U.S. firm would need to put in the bank today in order to have enough dollars to convert to pesos to pay the bill in six months. Show all your work.
• Calculate how many dollars the U.S. firm would have to convert to pesos today in order to have enough pesos in six months to pay the bill. Show all your work.