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An investor based in the United States is considering two one-year investment options. They can earn a 4% annual return on a domestic government bond. Alternatively, they can invest in a government bond from a developing country that offers a 12% annual return. The investor expects the developing country's currency to depreciate by 10% against the US dollar over the year. Based solely on these expected returns, which investment should the investor choose and why?
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Global Investment Decision Scenario
An investor based in the United States is considering two one-year investment options. They can earn a 4% annual return on a domestic government bond. Alternatively, they can invest in a government bond from a developing country that offers a 12% annual return. The investor expects the developing country's currency to depreciate by 10% against the US dollar over the year. Based solely on these expected returns, which investment should the investor choose and why?
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In a world with no capital controls, a rational investor seeking to maximize returns should always invest in the country offering the highest nominal interest rate, as this guarantees the highest return when converted back to their home currency.
A global investor based in Japan is comparing a 1-year Japanese government bond with a 1-year U.S. government bond. To make a rational decision about which asset offers a better return, which of the following pieces of information is MOST essential, in addition to the interest rates on both bonds?
An investor from a country with a 2% domestic interest rate decides to invest for one year in a foreign country's bonds that offer a 10% interest rate. At the end of the year, after converting the foreign currency back to their home currency, the investor discovers they have earned a negative overall return. Which of the following is the most plausible explanation for this outcome?
Inferring Exchange Rate Expectations
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Evaluating an Investment Strategy Based on High Nominal Interest Rates