The yield on a 1-year bill in the U.K. is 7%, and the present exchange rate is 1 pound = U.S. $1.65. If you expect the exchange rate to be 1 pound = U.S. $1.45 a year from now, the return a U.S. investor can expect to earn by investing in U.K. bills is
A) −6.7%.
B) 3.2%.
C) 8%.
D) −5.97%.
E) None of the options

Question

Quizplus · Accepted Answer

The expected return for a U.S. investor investing in U.K. bills involves both the yield on the bill and the change in the exchange rate. The yield on the bill is 7%. The change in the exchange rate from $1.65 to $1.45 per pound represents a depreciation of the pound against the dollar. The expected return in dollar terms can be calculated as follows:1. Calculate the initial investment in dollars for purchasing 1 pound worth of U.K. bills: $1.65.2. Calculate the value of this investment a year later, including the 7% yield: 1 pound * (1 + 7%) = 1.07 pounds.3. Convert this value back to dollars using the expected future exchange rate: 1.07 pounds * $1.45/pound = $1.5515.4. Calculate the return in dollars: [(1.5515 - 1.65) / 1.65] * 100 = -5.97%.Therefore, the expected return for a U.S. investor is -5.97%.

The Yield on a 1-Year Bill in the U