Suppose an investor buys a UK bond with a coupon rate of 8% at its price of £990.The bond's face value is £1,000.If the British pound depreciates by 5%,at what end- of-year selling price of this bond will the dollar return on the bond just equal 10%?

Question

Quizplus · Accepted Answer

The initial investment is £990 for a bond with face value of £1,000 and coupon rate of 8%. Therefore, the annual coupon payment is:

Coupon payment = 8% x £1,000 = £80

If the British pound depreciates by 5%, it means that the new exchange rate is £1 = $0.95. Therefore, the initial investment in dollars is:

Initial investment = £990 x $0.95 = $940.50

Let's assume that the end-of-year selling price of the bond is x pounds. The total return in pounds, including coupon payment, is:

Total return = coupon payment + (selling price - buying price)

Total return = £80 + (x - £990)

To find the selling price that would give a dollar return of 10%, we need to convert the total return in pounds to dollars using the new exchange rate. We also know that the initial investment in dollars was $940.50, and we want a total dollar return of 10%. Therefore:

0.1 = (total return in dollars / initial investment in dollars)

0.1 = ((total return in pounds x exchange rate) / $940.50)

Solving for the selling price (x), we get:

x = (£990 + ($0.095 x $940.50 - £80)) / (1 - 0.05)

x = £1,061.58

Therefore, the end-of-year selling price of the bond that would give a dollar return of 10% is approximately £1,062, which is closest to choice A) 1062.

Suppose an Investor Buys a UK Bond with a Coupon