One-Year Investment Horizon Assumption

Home Policy Rate (i)

Numerical Example of US and South African Policy Rates

Investor's Focus on Home Currency Rate of Return

Numerical Example of Expected Currency Depreciation (δ^E = 2.5%)

Risk of Currency Depreciation Offsetting High Interest Rates

Analytical Framework: Defining Home and Foreign Economies in the Investment Example

A manager of a US-based fund, whose obligations are in US dollars, is evaluating three one-year bond investment options to maximize the fund's return in US dollars. The options are:

1. A US government bond with a guaranteed 3% annual return.
2. A bond from Country A offering an 8% annual return in its local currency, which is expected to depreciate by 6% against the US dollar over the year.
3. A bond from Country B offering a 4% annual return in its local currency, which is expected to appreciate by 2.5% against the US dollar over the year.

Based on the goal of maximizing the expected return in US dollars, which investment should the manager choose?

Foreign Bond Investment Analysis

Foreign Investment Decision Analysis

A US-based investment fund, which measures its returns in US dollars, is considering two one-year investment options. Option A is a US Treasury bond with a 4% annual yield. Option B is a South African government bond with a 7% annual yield, denominated in South African rand. Financial analysts predict that the South African rand will depreciate by 5% against the US dollar over the next year. Given this information, the South African bond is the more profitable investment for the fund.