Hong Kong bond with a coupon of 10% is initially priced at HK$1,000.At the end of the year,the bond is selling for HK$1,200.If the Hong Kong dollar depreciates by 5%,what will the U.S.dollar return on the bond equal at the end of the year?

Question

Quizplus · Accepted Answer

The U.S. dollar return on the bond can be calculated in two parts: the return from the bond in HKD and the effect of the currency depreciation. Initially, the bond is priced at HK$1,000 and pays a 10% coupon, which equals HK$100. At the end of the year, the bond is selling for HK$1,200, so the total return in HKD is HK$300 (HK$100 from the coupon and HK$200 from the price increase), which is a 30% return in HKD terms (HK$300 / HK$1,000). However, the HKD depreciates by 5% against the USD. Therefore, the USD return is 30% - 5% = 25%. But, because the depreciation affects the entire value of the investment, not just the return portion, the calculation should factor in the depreciation on the total value, not just subtract it. The correct approach is to adjust the total HKD return by the depreciation rate: HKD return * (1 - depreciation rate) = 30% * (1 - 0.05) = 30% * 0.95 = 28.5%. However, this calculation seems to have been misunderstood in the setup, leading to an incorrect explanation. The correct calculation for the USD return, taking into account the depreciation correctly, would involve understanding the final value in USD, considering both the investment return and the currency depreciation effect. Given the choices, the closest correct answer provided is 23.5%, which suggests a misunderstanding in the explanation process. The actual calculation should consider the initial investment, the return in local currency, the depreciation effect on the entire amount, and then convert this to the percentage return in USD. The provided options and the correct calculation methodology do not align perfectly, indicating a mistake in the explanation process.

Hong Kong Bond with a Coupon of 10% Is Initially