Example 2: An investor in her home currency wud like to expand her portfolio to include 1 yr bonds in foreign countries. The expected inflation in DC is 3 %, in Fc is 1pc. inflation rates are totally predictable over next year. Exchange rate b/w 2 countries is currently 2 DC units per FC unit. The price level of consumption basket in domestic country relative to foreign country is 2 is to 1. The real exchange rate is 1 to 1. the 1 year interest rate is 5pc flor DC and 3pc for FC. Investor expects real exchange rate to remain constant over time.
Q What are the expected exchange rate & expected return on the foreign bond in domestic currency.
Please help out with second part(expected return on foreign bond)..I am unable to understand the solution provided by CFAI.作者: Sportsman 时间: 2011-7-13 13:54
you earn 3% on the bond in FC and because DC depreciated, your return in DC is higher due to the depreciation.
you invest 100 DC convert it into FC say at 1:1 and earn 3 %, say 103 FC and you convert it back at new rate 1.02 DC per 1 FC, and you receive 103 x 1.02 = 105.06作者: thecfawannabe 时间: 2011-7-13 13:54
makes sense what you are saying, but I was attempting it using this
Return = R (FC) + currency return
using this, I got 5 = 3(foreign int rate) + 2(currency movement %)
What is wrong with my approach, since this is the equation that shud be used for calculating return. Please advice....作者: President1988 时间: 2011-7-13 13:54
this is simplified calculation that you use, this should be enough for exam, I would use this too (depending on the given answers)
