Question

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Suppose you inherit $5 million from your uncle. The interest rate on Australian government bonds is...

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

The following are the spot and the swap rates of the USD/SFr

Spot 0.6963-0.6968

90-day swap rates 9-14

This means that:

A.

The Swiss Franc is trading at a forward discount
B.

There is greater certainty about future rates
C.

The US dollar is trading at a forward premium
D.

The Swiss Franc is trading at a forward premium

Solutions

Expert Solution

1]

If Australian bond is purchased, $ received after 1 year = $5,000,000 * (1 + 5%) = $5,250,000

If Peruvian bond is purchased, $ received after 1 year = $5,000,000 * (1 + 14%) / (1 + 11%) = $5,135,135

Therefore, the Australian bond should be purchased.

The answer is (A)

2]

C - The US dollar is trading at a forward premium

This is because each US dollar can buy a higher quantity of Swiss Franc in the future (after 90 days) than in the spot market. This is indicated by the swap rate, which is quoted as a premium over the spot rate.

jeff jeffy answered 2 years ago
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