Foreign Policy Rate (i*)
The foreign policy rate, denoted as , represents the rate of return on risk-free assets in the foreign economy from the perspective of the domestic economy being analyzed. In macroeconomic models analyzing an open economy, the foreign policy rate typically represents the interest rate of a major global economy, such as the United States. For a US-based global investor, this rate serves as the benchmark return available on their own risk-free home currency assets, such as US government bonds.
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Foreign Policy Rate (i*)
An investor based in Australia is considering purchasing corporate bonds issued by a company in the United Kingdom. To decide if this foreign investment is worthwhile, the investor needs a fundamental baseline for comparison. Which of the following represents the most appropriate benchmark for this Australian investor?
Critique of the Universal Investment Benchmark
Global Investment Decision Benchmark
Rationale for the Home Currency Benchmark
A Canadian investor is evaluating an investment in a German technology startup. To determine the minimum acceptable return, the investor should use the interest rate on a German government bond as their primary benchmark.
An international investment firm employs analysts from various countries. For each analyst evaluating a potential foreign investment, match them with the most appropriate risk-free benchmark they should use for their comparison.
A French investor determines that a risk-free investment in their own country yields a 2% annual return. They are evaluating a foreign investment opportunity that, after adjusting for all relevant risks and currency fluctuations, is projected to yield 1.5%. The investor should reject this opportunity because its adjusted return is less than the return available from their __________.
An investor from South Korea is considering an investment in Brazilian government bonds. Arrange the following steps in the logical order they would follow to make a decision using their home currency's risk-free asset as a benchmark.
An investor based in Switzerland has historically found it profitable to invest in a portfolio of foreign corporate bonds, as their returns consistently exceeded the 1% yield on Swiss government bonds. Recently, the Swiss central bank increased its key interest rate, causing the yield on Swiss government bonds to rise to 4%. Assuming the expected returns and risks of the foreign bonds remain the same, what is the most likely consequence for the investor's strategy?
Evaluating an Investment Manager's Rationale
Learn After
Identifying the Foreign Policy Rate
An investor based in the United Kingdom is evaluating an opportunity to purchase government bonds in Canada. The interest rate on risk-free UK government bonds is currently 4.5%, while the interest rate on risk-free Canadian government bonds is 3.8%. From the perspective of the UK-based investor, what is the foreign policy rate (i*)?
A German investor is considering purchasing U.S. Treasury bonds. In this scenario, the interest rate on German government bonds would be considered the foreign policy rate (i*).
Applying the Concept of the Foreign Policy Rate
A central banker in Japan is analyzing capital flows between Japan and Australia. The current policy interest rate in Japan is 0.1%, while in Australia it is 4.35%. When modeling the decision of an Australian resident to invest in Japanese government bonds, what value represents the foreign policy rate (i*)?
An investor from Canada is comparing the potential return from a Canadian government bond to that of a German government bond. In this context, the interest rate on the German bond is referred to as the foreign policy rate (i*). What is the primary analytical purpose of identifying this specific rate for the Canadian investor?
An investment analyst is examining capital flows between the United States and Switzerland. The current risk-free interest rate on government bonds is 1.5% in Switzerland and 5.25% in the United States. When evaluating the decision of a Swiss-based pension fund to invest in US government bonds, which rate should the analyst use as the foreign policy rate (i*)?
Analyzing Capital Flow Incentives
An analyst based in Mexico is evaluating an investment in a risk-free government bond issued by South Korea. Match each economic term to its correct description or location within this specific scenario.
Evaluating Investment Attractiveness
Numerical Example of US and South African Policy Rates