uestion One:Suppose you have $10,000 that you wish to invest. For each of the fo
ID: 2806573 • Letter: U
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uestion One:Suppose you have $10,000 that you wish to invest. For each of the following scenarios explain whether you would be better off putting your money in the foreign or e iwenty minutes each. Do each question in order. u will invest for one year. (hint compare the returns on each investment). Explain a Yo assumptions you make. US assets ny an interest rate of 25%. exchange rate will be 3.0 in a year. The annual interest rate on US corporate bonds is 5% while corporate bonds in Brazil carry The current exchange rate is 2.0 Cruzados per dollar. You expect that the e The annual interest rate for bank deposits in Euros is 2.5% while that on US dollar deposits is 3.5%. A Euro costs 1.20 dollars. The forward exchange rate for next year is 1.30 dollars per The US interest rate is 5% while the interest rate in Australia is 10%. You have no other information.Explanation / Answer
a. Return on US assets = 10000*5%= $500
On Brazilian investment
Total investment = $10000*2 = 20000 cruzados
Interest = 20000* 25% = 5000 Cr
End of year investment in USD = 25000/3= $ 8333
Loss = $10000 - $8333 = $1667
The return on US assets is higher in this case.
2. Return on US asset = 10000*3.5% = $350
On Euro investment
Total investment = $10000/1.2 = 8333.33 Euros
Interest = 8333.33 * 2.5% = 208.33 Euro
End of year investment in USD = (8333.33 + 208.33)* 1.3 = $11,104. 16
Return on investment = 11104.16- 10000 = $1,104.16
Hence the return is higher when investment is made in Euros.
3. Suppose current exchange rate is 1 USD = 1.3 AUD
Assuming interest rate parity F = S * ((1 + if) / (1 + id)).
F = 1.3* 1.1/1.05
F = 1.3619 AUD per USD
Return on US asset = 10000*5% = $500
On AUD investment
Total investment = $10000*1.3 = 13000 AUD
Interest = 13000*10% = 1300 AUD
End of year investment in USD = (13000+ 1300)/ 1.36 = $ 10,500
Return on investment = $500
Hence the return is same since we assumed interest rate parity.
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