A zero-coupon British bond promises to pay £100,000 in five years.The current exchange rate is $2.00 = £1.00 and inflation is forecast at 3 percent in the U.S.and 2 percent in the U.K.per year for the next five years.The appropriate discount rate for a bond of this risk would be 10 percent if it paid in dollars.What is the appropriate price of the bond?

Question

Quizplus · Accepted Answer

First, we need to calculate the future value of the bond in pounds after five years, considering the inflation rate in the U.K.:

FV = £100,000 x (1 + 0.02)^5 = £110,408.08

Next, we need to calculate the equivalent value of the bond in dollars, using the current exchange rate and the forecasted inflation rate in the U.S.:

110,408.08 / (1 + 0.03)^5 x 2.00 = $142,551.41

Finally, we can discount the future value of the bond at the appropriate discount rate of 10%:

PV = $142,551.41 / (1 + 0.10)^5 = $77,696.13

Therefore, the appropriate price of the bond is £65,196.13 or $130,392.26 (assuming the exchange rate remains at $2.00 = £1.00). Option B is the correct answer.

A Zero-Coupon British Bond Promises to Pay £100,000 in Five