Assume that the U.S. one-year interest rate is 3% and the one-year interest rate on Australian dollars is 6%. The U.S. expected annual inflation is 5%, while the Australian inflation is expected to be 7%. You have $100,000 to invest for one year and you believe that PPP holds. The spot exchange rate of an Australian dollar is $0.689. What will be the yield on your investment if you invest in the Australian market?

Question

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SOLUTION:
$\begin{array} { l } 
( 1 + .05 ) / ( 1 + .07 ) \times \$ 0.689 = \$ 0.676 . ( \$ 100,000 / \mathrm { A } \$ 0.689 ) \times ( 1 + .06 ) = \
\mathrm { A } \$ 153,846 \times \$ 0.676 = \$ 104,000 . ( \$ 104,000 - \$ 100,000 ) / \$ 100,000 = 4 \%
\end{array}$

Assume That the U