Investment Condition: Compensating for Expected Depreciation
For a foreign investment to be attractive despite an expected depreciation of the foreign currency (), the nominal interest rate differential in its favor must be large enough to compensate for the anticipated loss from currency conversion. An investor will only consider the foreign asset if its interest rate () exceeds the home interest rate () by at least the expected rate of depreciation. This decision rule can be expressed as the condition: .
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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?
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A Canadian investor is considering purchasing a one-year government bond from Australia. The Australian bond offers a nominal interest rate of 5.5%. The investor's home policy rate in Canada is 4.0%. Financial analysts expect the Australian dollar to depreciate by 2.0% against the Canadian dollar over the next year. Based on the standard approximation formula, what is the investor's expected nominal rate of return in Canadian dollars?
An international investor is monitoring a government bond from Country X. The nominal interest rate on this bond has not changed. However, the investor's projected rate of return, once converted back to their home currency, has recently decreased. According to the standard approximation formula for foreign investment returns, which of the following events is the most plausible cause for this decrease?
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Learn After
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An investor is considering a foreign bond that offers a nominal interest rate 4 percentage points higher than a comparable domestic bond. If the investor expects the foreign currency to depreciate by 5% over the investment period, this foreign investment is considered financially attractive.
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