Question 1

The interest rate on a 1-year Canadian security is 7.8%. The current exchange rate is C$ = US $0.79. The 1-year forward rate is C$ = US $0.77. The return (denominated in U.S. $) that a U.S. investor can earn by investing in the Canadian security is

Accepted Answer

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Question 2

Suppose the 1-year risk-free rate of return in the U.S. is 4% and the 1-year risk-free rate of return in Britain is 6%. The current exchange rate is 1 pound = U.S. $1.67. A 1-year future exchange rate of __________ for the pound would make a U.S. investor indifferent between investing in the U.S. security and investing in the British security.

Accepted Answer

To make a U.S. investor indifferent between investing in the U.S. and Britain, the future exchange rate must offset the interest rate differential. The calculation is as follows: Start with $1.67, the current exchange rate. If $1 is invested in the U.S. at 4%, it grows to $1.04 in a year. To match this in Britain, where the rate is 6%, you convert your dollars to pounds at the current rate ($1.67), invest at 6%, and then convert back at the future rate. The calculation for the future rate needed to break even is: $1.67 * (1 + 0.06) / (1 + 0.04) = $1.6385.

Question 3

You are a U.S. investor who purchased British securities for 2,200 pounds one year ago when the British pound cost $1.50. No dividends were paid on the British securities in the past year. Your total return based on U.S. dollars was __________ if the value of the securities is now 2,560 pounds and the pound is worth $1.60.

Accepted Answer

The initial investment in USD was 2,200 pounds * $1.50 = $3,300. The current value in USD is 2,560 pounds * $1.60 = $4,096. The return is ($4,096 - $3,300) / $3,300 = 24.1%.

Question 4

An investor invests in a Japanese bond at 5.5% for one year. The equivalent USA investment yields 3.8%. If the spot exchange rate is 110.00 yen per USD, what is the expected forward exchange rate in yen per USD?

Accepted Answer

The correct answer is A because the expected forward exchange rate is 111.80 yen per USD. This is because the investor will receive a higher return on the Japanese bond than on the USA investment, so they will need to sell yen to buy dollars in order to invest in the Japanese bond. This will increase the demand for yen and decrease the demand for dollars, which will cause the yen to appreciate against the dollar.

Question 5

An investor invests in a Mexican treasury at 9% for one year. The equivalent USA investment yields 5%. If the spot exchange rate is 13.000 pesos per USD, what is the expected forward exchange rate in pesos per USD?

Accepted Answer

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Question 6

You are a U.S. investor who purchased British securities for 4,000 pounds one year ago when the British pound cost $1.50. No dividends were paid on the British securities in the past year. Your total return based on U.S. dollars was __________ if the value of the securities is now 4,400 pounds and the pound is worth $1.62.

Accepted Answer

The initial investment was 4,000 pounds * $1.50 = $6,000. The current value is 4,400 pounds * $1.62 = $7,128. The return is ($7,128 - $6,000) / $6,000 = 18.8%.

Question 7

Suppose the 1-year risk-free rate of return in the U.S. is 6%. The current exchange rate is 1 pound = U.S. $1.62. The 1-year forward rate is 1 pound = $1.53. What is the minimum yield on a 1-year risk-free security in Britain that would induce a U.S. investor to invest in the British security?

Accepted Answer

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Question 8

Suppose the 1-year risk-free rate of return in the U.S. is 4.5% and the 1-year risk-free rate of return in Britain is 7.7%. The current exchange rate is 1 pound = U.S. $1.60. A 1-year future exchange rate of __________ for the pound would make a U.S. investor indifferent between investing in the U.S. security and investing in the British security.

Accepted Answer

To make a U.S. investor indifferent between investing in the U.S. and Britain, the future exchange rate must offset the interest rate differential. The calculation involves finding the expected future exchange rate that equalizes the returns, using the formula: Future Exchange Rate = Current Exchange Rate * (1 + Foreign Interest Rate) / (1 + Domestic Interest Rate). Plugging in the given values: 1.60 * (1 + 0.077) / (1 + 0.045) = 1.60 * 1.077 / 1.045 ≈ 1.5525.

Question 9

An investor invests in a Japanese bond at 7.0% for one year. If the spot exchange rate is 104.00 yen per USD and the one year forward exchange rate is 99, what return should the investor expect on an equivalent USD investment?

Accepted Answer

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Question 10

An investor invests in a Japanese bond at 6% for one year. The equivalent USA investment yields 7%. If the spot exchange rate is 104.00 yen per USD, what is the expected forward exchange rate in yen per USD?

Accepted Answer

The expected forward exchange rate can be calculated using the interest rate parity formula, which states that the forward exchange rate should adjust so that the return on a domestic bond is equal to the return on a foreign bond, when measured in the same currency. The formula is: Forward Rate = Spot Rate * (1 + Domestic Interest Rate) / (1 + Foreign Interest Rate). Plugging in the given values: Forward Rate = 104 * (1 + 0.07) / (1 + 0.06) = 104 * 1.07 / 1.06 ≈ 103.03 yen per USD.

Question 11

The present exchange rate is C$ = U.S. $0.78. The 1-year future rate is C$ = U.S. $0.75. The yield on a 1-year U.S. bill is 5%. A yield of __________ on a 1-year Canadian bill will make investor indifferent between investing in the U.S. bill and the Canadian bill.

Accepted Answer

To make investors indifferent, the return on the Canadian bill should compensate for the expected depreciation of the Canadian dollar. The expected depreciation is (0.78 - 0.75) / 0.78 = 3.85%. Adding this to the U.S. yield of 5% gives approximately 8.85%. The closest option is 9.2%.

Question 12

An investor invests in a Japanese bond at 6.5% for one year. If the spot exchange rate is 110.00 yen per USD and the one year forward exchange rate is 112, what return should the investor expect on an equivalent USD investment?

Accepted Answer

The investor earns 6.5% in yen terms. However, the yen is expected to depreciate from 110 to 112 per USD. The expected return in USD is calculated as: (1 + 0.065) * (110/112) - 1 = 4.60%.

Quiz 25: International Diversification