A zero-coupon French bond promises to pay €100,000 in five years. The current exchange rate is $1.50 = €1.00 and inflation is forecast at 3% in the U.S. and 2% in the euro zone per year for the next five years. The appropriate discount rate for a bond of this risk would be 10% if it paid in dollars. What is the appropriate price of the bond?

Question

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The correct answer is A because the appropriate price of the bond is £65,196.13 = $97,794.20. This is because the bond is a zero-coupon bond, which means that it does not pay any interest payments. The only payment that the bondholder receives is the face value of the bond at maturity. The appropriate discount rate for a bond of this risk would be 10% if it paid in dollars. However, since the bond is denominated in euros, we need to adjust the discount rate for the difference in inflation rates between the U.S. and the euro zone. The inflation rate in the U.S. is forecast to be 3% per year for the next five years, while the inflation rate in the euro zone is forecast to be 2% per year for the next five years. This means that the real discount rate for the bond is 10% - 3% = 7%. Using this discount rate, we can calculate the present value of the bond as follows:PV = €100,000 / (1 + 0.07)^5 = €65,196.13Converting this to dollars at the current exchange rate, we get:PV = €65,196.13 * $1.50/€1.00 = $97,794.20

A Zero-Coupon French Bond Promises to Pay €100,000 in Five