Suppose Australia's one- year interest rate is 4% per year, while a foreign country has a one- year interest rate of 6% per year. Ignoring risk and transaction costs, an Australian investor should invest in foreign bonds as long as the expected yearly rate of depreciation of the foreign currency is:
A) greater than 5%.
B) less than 2%.
C) less than 1%.
D) greater than 2%.
E) less than 5%.

Question

Quizplus · Accepted Answer

In order for an Australian investor to invest in foreign bonds, the expected return from the foreign currency should be higher than the difference in interest rates (i.e. 6% - 4% = 2%). Therefore, the Australian investor should invest in foreign bonds as long as the expected yearly rate of depreciation of the foreign currency is less than 2%. Therefore, the correct choice is B, less than 2%.

Suppose Australia's One- Year Interest Rate Is 4% Per Year