Final answer:
The treasurer would earn a higher return by investing in the UK when considering both the higher interest rates and the forward exchange rate, with additional earnings of approximately $117,789.97 over those if the funds were invested in the U.S.
Step-by-step explanation:
To determine where the treasurer of a major U.S. firm should invest the $12 million for three months, we need to compare the potential earnings in both the U.S. and the UK. By investing in the U.S. at an interest rate of 0.42 percent per month, the calculation would be $12,000,000 * (1 + 0.0042)^3, which would yield a final amount of $12,151,885.56. Therefore, the total interest earned in the U.S. would be $151,885.56.
Alternatively, investing in the UK at 0.52 percent per month, we need to account for both the interest and the expected change in the exchange rate. The initial investment is to be converted into pounds at the spot rate, and then back into dollars at the forward rate. Investing $12,000,000 at the spot rate of £0.70 yields £8,571,428.57.
This amount will grow at 0.52 percent for three months, resulting in £8,591,597.30. Converting back to dollars at the forward rate of £0.71, this amount is $12,269,675.53. The interest earned here would be $269,675.53.
Based on purely financial calculations and ignoring transaction costs or any other potential risk factors, the treasurer would earn a higher return by investing in the UK with additional earnings of $117,789.97 because $269,675.53 (interest from investing in UK) - $151,885.56 (interest from investing in US) = $117,789.97. However, this does not factor in transaction costs or exchange rate risk beyond the three-month period.