Question

In: Finance

On February 26, 2015, an American company, Company A, sold an euro-denominated eight- year bond at...

On February 26, 2015, an American company, Company A, sold an euro-denominated eight- year bond at a fixed interest rate of 1%. In comparison, a similarly rated company, Company B, sold a bond with the same maturity in the U.S. with a coupon of 2.5%. The exchange rate on February 26, 2015 was $1.1199/€. Assume that the International Fisher Effect holds true. What will be the total expected foreign exchange gain or loss for both the interest payment and the value of the bond (in percentage) for Company A each year in the next eight years?

Your answer: _______________%

(Keep two decimals; Do include the "-" if your answer is a loss.)

Expert Solution

International fisher effects theory

Mathematically it is expressed as ,

et = expected exchange rate at time period t (?)

eo = current exchange rate ( $ 1.1199)

ih,t = interest rate of home currency ( 1 % = 0.01 )

if,t = interest rate of foreign currency ( 2.5 % = 0.025 )

= $ 1.1035

Now , from the equation regarding equality of interest rate differential and change in the exchange rate, the expected year - end nominal interest rate in America can be estimated as follows :

%

et/eo = 1+ih,t/1 + ift

et = co(1 + ih,t/1 +if,t)

et = 1.1199(1 + 0.01/1+ 0.025)

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