Consider two bonds, one issued in euros in Germany, and one issued in dollars in the...

Consider two bonds, one issued in euros in Germany, and one issued in dollars in the US.

Assume that both government securities are one-year bonds – paying the face value of the bond

one year from now. The exchange rate, E, stands at 0.75 euros per dollar.

The face values and prices on the two bonds are given by:

US:
Face Value: $10,000 Price: $9,615.38

Germany:
Face Value: $10,000 euros : 9,433.96 euros

a.Compute the nominal interest rate on the bonds.

b. Compute the expected exchange rate next year consistent with uncovered interest parity.

c. If you expect the dollar to depreciate relative to the euro, which bond should you buy?

d. Assume that you are a US investor and you exchange dollars for euros and purchase the

German bond today. One year from now, it turns out that the exchange rate, E, is actually

0.72 (.72 euros buys one dollar). What is your realized rate of return in dollars compared to

the realized rate of return you would have made had you held the US bond?

Solutions

Expert Solution

Rahul Sunny answered 1 year ago

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