Darien

This is a legitimate question. And rather straightforward if you ask me.

Rb = Rl + Rc


Where:
Rb = Return on Bond (Domestic Currency)
Rl = Return on Bond (Local Currency)
Rc = Return on Currency Implied by Market (i.e., forward premium/discount)*
= (Forward - Spot ) / Spot

As such:

5.60% = 8.5% + [(0.67-0.69)/0.69)]

5.60% = 8.5% + (-2.9%)


*You cannot use IRP here, because IRP is theory, not actual market numbers. You cannot hedge IRP, but you can hedge using forwards in the markets. That is why the discount is not -3.3%. This is the forward discount IMPLIED by IRP theory.



Edited 1 time(s). Last edit at Wednesday, June 1, 2011 at 01:30PM by forzajuve.