Question

Suppose you inherit $5 million from your uncle. The interest rate on Australian government bonds is 5% while Peruvian government bonds carry an interest rate of 14%. Also suppose that you expect the Peruvian currency (the new sol) to depreciate by 11% relative to the Aussie dollar. Assuming you do not care about uncertainty, which bond should you purchase?

A.
Australian bond

B.
You are indifferent between the two

C.
Peruvian bond

Answer 1

The correct answer is Peruvian Bond

The Peruvian government bond is giving 14% while the australian bond is giving 5%, which rmans that the rate of return on the former one is higher than the latter one, so it should be preferred even though the currency is going to depreciate by 11% of peru in comparison to australian dollars.

After depreciating rate of return of Peruvian Bond = 14% * ( 1 - 11%)

= 12.46%

Still, the peruvian bond is giving higher return, therefore, it should be preferred.