Suppose the 1-year risk-free rate of return in Canada.is 6%.The current exchange rate is 1 pound = Cad $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 Canadian investor to invest in the British security?

Question

Quizplus · Accepted Answer

To determine the minimum yield on a 1-year risk-free security in Britain that would induce a Canadian investor to invest in the British security, we need to compare the return that the Canadian investor would receive from investing in Canada to the return that they would receive from investing in Britain.

If the Canadian investor were to invest in Canada, they would receive a return of 6%.

If the Canadian investor were to convert their Canadian dollars to pounds and then invest in Britain, they would be able to lock in a return of 1 pound = $1.53 in 1 year. However, they would need to convert their pounds back to Canadian dollars in 1 year's time, at the prevailing spot rate.

If the prevailing spot rate in 1 year's time is worse for the Canadian investor (i.e. more pounds are required to buy 1 Canadian dollar), then their return from investing in Britain would be reduced. Therefore, the minimum yield on a 1-year risk-free security in Britain that would induce a Canadian investor to invest in the British security can be calculated as follows:

6% = [(1 + minimum yield in Britain) * (1.62/1.53)] - 1

Minimum yield in Britain = 12.24%

Therefore, the answer is C.

Suppose the 1-Year Risk-Free Rate of Return in Canada