Question

A U.S.-based importer, Zarb, invests $1000 in a risk-free 180-day Switzerland bond with a 4% annual Swiss francs return. He plans to lock in the dollar return by selling the Swiss francs in the forward market. Assume that the spot exchange rate is 1.66 Swiss francs per dollar and the 180-day forward exchange rate is 0.6 dollar per Swiss francs. What's the expected annual dollar return?

Answer 1

Answer:-

Zarb had $ 1000

Step 1:- He converted it into Swiss Franc at spot exchange rate is 1.66 Swiss francs per dollar = $1000 x 1.66 = 1660 Francs

Step 2 :- Invested 1660 Francs in 180 day switzerland bond

Interest 1660 x 2% = 33.2 Swiss Francs (4% being annual interest Rate, 2% will be the rate for 180 days                assuming year to be 360 days)

Total Swiss francs at the end of 180 days = 1660 + 33.2 = 1693.2 Swiss Francs

Step 3:- Convert 1693.2 Swiss Francs into Dollar

1693.2 x 0.6 = $ 1015.92

Return for 180 days = $1015.92 - Initial Investment

                                   = $1015.92 - $ 1000 = $15.92

Return for 180 days = 15.92/1000 = 1.59%

Annual Return = 1.59 x 2 = 3.18%