A 5 percent-annual coupon British has a par value of £1,000,matures in five years,and has a yield to maturity of 4 percent.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.If a dollar-based investor used forward contracts to redenominate this bond into dollars,what would be his rate of return?

Question

Quizplus · Accepted Answer

The correct answer is A because the 5 percent coupon payment is fixed in British pounds, and the exchange rate is fixed by the forward contract. Therefore, the dollar-based investor will receive a 5 percent return on his investment, regardless of changes in the exchange rate or inflation.

A 5 Percent-Annual Coupon British Has a Par Value of £1,000,matures