Question

Anne, who is a Canadian saver, would like to invest
$65,000 dollars (Canadian dollars to be precise). She is considering two options,
buying a Canadian discount bond or a Russian discount bond, and Anne would like
you compare returns on both options. The world risk-free rate is 0.25%. There is
no risk premium on the Canadian discount bond, and the risk premium on the
Russian discount bond is 5%. The current nominal Russian-Canadian exchange
rate is ecan=56 Rubbles (Rubbles per Canadian dollar). Before the pay-out next
period, you expect (and of course, Anne agrees with you), Rubbles will depreciate
relative to Canadian dollar, efuture=60 Rubbles (again, Rubbles per Canadian
dollar). Based on your forecast, what is the expected rate of return (% yield) on
each investment. For simplicity, please assume zero transaction costs and no
difference in taxes (zero taxes on both options). Please note, to get full points, you
need to show all your steps.

Answer 1

Answer:-

If Anne invests in Canadian discount bond for a year,

She earns associate degree interest of $ 65,000 * 0.25% = $ 162.5

Total expected come back on Canadian discount bond being 0.25%

If Anne invests in Russian discount bond for a year,

First she should convert Canadian dollars into Russian Rubbles

so we've got a bent to induce $ 65,000 * 56 Rubbles per dollar = 3,640,000 Rubbles

The charge per unit Russian discount bond as per CAPM is,

Risk Free Rate + Risk Premium = 0.25% + 5 %= 5.25%

She earns associate degree interest of 3,640,000 Rubbles * 5.25% = 191,100 Rubbles

Investment Totals with interest = 3,640,000 Rubbles + 191,100 Rubbles

= 3,831,100 Rubbles

Converting Rubbles into Canadian $ we've got a bent to induce

3,831,100 Rubbles / 60 Rublles per Canadian $ = $ 63,851.67

Total Loss = $ 65,000 - $ 63,851.67 = $ 1,148.33

Total expected come back on Russian discount bond

being -1.767% (-1148.33/65000*100)

Conclusion :- Canadian Discount Bond may well be a better Investment idea.