PM: very similar questions, but Schweser and CFAI answer the exchange, domestic, currency

joemoran

A U.S. investor purchased a U.K. bond one year ago. The exchange rate at the time was 1.5 to 1 (dollars to pounds) and the beginning-of-period ratio of the price levels of the consumption baskets was 2 to 1 (dollars to pounds). Beginning of the year interest rates were 7% in the U.S. and 12% in the U.K. Inflation during the year was expected to be 5% in the U.S. and 10% in the U.K. Today the exchange rate is 1.6. What is the ex-post domestic currency return on the U.K. bond to the U.S. investor?
A) 14.67%.
B) 18.67%.
C) 5.33%.
Your answer: A was incorrect. The correct answer was B) 18.67%.
The dollar was expected to appreciate (lower inflation), but depreciated by 6.67% (= 1.6 / 1.5 = 1.0667 or 6.67%) instead. Hence, the return to U.S. investor is the foreign interest rate plus currency appreciation, or 18.67% (= 12% foreign rate + 6.67% appreciation).
*****—— NOTE: ACCORDING TO SCHWESER WE ADD 12% TO 6.67% TO GET 18.67%
Similar question using CFAI textbook
Reading #66, #7A: A PM based in the UK is planning to invest in US bonds with a maturity of one year. Assume that the ratio of the price levels of a typical consumption basket in the UK versus the US is 1.2 to 1. The current exchange rate is L.69 per dollar. The one year interest rate is 1.76% in the US and 4.13% in the UK. Assume that inflation rates are fully predictable, and expected inflation over the next year is 1.5% in the US and 3.75% in the UK.
The inflation differential between the UK and the US is 2.25%
The expected exchange rate is __________?
answer: .69 x (1+.0225) = L.7055/$1
The expected return on the US bond = __________?
answer: (1+.0176)(1+.0225)-1 = .0405 = 4.05%
****** THIS IS MY QUESTION: SCHWESER ASKS BASICALLY THE SAME QUESTION, BUT IN THE END ADDS THE TWO TOGETHER.
CFAI MULTIPLIES THE RESULTS TOGETHER. THE NUMBERS ARE SIMILAR, BUT NOT THE SAME, AND ACTUALLY NOT THE CLOSE.
WHAT IS THE RIGHT WAY TO ANSWER THIS QUESTION? PROBABLY DO WHAT CFAI ASKED BECAUSE THEY WRITE THE TEST.
ANY FEEDBACK HELPS