Inferring Currency Expectations
An international investor observes that two different foreign government bonds are offering approximately the same nominal rate of return when measured in the investor's home currency. Bond A, from Country A, offers a 6% nominal interest rate. Bond B, from Country B, offers a 9% nominal interest rate. Based on this information, what can you infer about the market's expectation regarding the future value of Country B's currency compared to Country A's currency, relative to the investor's home currency? Justify your reasoning.
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An American investor is considering a foreign bond that pays a nominal interest rate of 4%. Over the investment period, the foreign currency in which the bond is denominated is expected to appreciate by 1.5% against the US dollar. Using the approximation formula for calculating the return in an investor's home currency, what is the investor's expected nominal rate of return in US dollars?
Inferring Currency Expectations
An investor is evaluating two separate foreign government bonds.
- Bond X is issued in a country where the nominal interest rate is 7%, and the local currency is expected to depreciate by 4% against the investor's home currency.
- Bond Y is issued in a different country where the nominal interest rate is 5%, and the local currency is expected to depreciate by 1.5% against the investor's home currency.
Using the standard approximation for calculating the rate of return in the investor's home currency, which statement accurately compares the expected returns?
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