Numerical Example of US and South African Policy Rates
To provide a concrete illustration for the investment decision between US and South African assets, specific values are assigned to the relevant policy rates. The US policy rate (), representing the return on risk-free dollar assets, is assumed to be 4%. Concurrently, the South African policy rate (), representing the return on rand-denominated assets, is assumed to be 6.5%.
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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:
- A US government bond with a guaranteed 3% annual return.
- 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.
- 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.
Approximation Formula for Foreign Investment Return in Home Currency
An investment manager for a US-based fund is comparing two one-year government bonds. The first is a US government bond offering a 3% annual return. The second is a government bond from Country Z, offering a 7% annual return, with the return guaranteed in Country Z's local currency. To accurately compare the potential returns in US dollars, which of the following pieces of information is most essential for the manager to consider?
Evaluating Foreign Investment Returns
Risk Assessment of Foreign Bonds
A Japanese investor is considering buying a one-year government bond from Australia. The Australian bond offers a 5% annual interest rate, guaranteed in Australian dollars. Based on this information, the Japanese investor is guaranteed to receive a 5% return on their investment when measured in Japanese yen.
Numerical Example of US and South African Policy Rates
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
Learn After
A US-based investor observes that a one-year US government bond offers a 4% return, while a one-year South African government bond offers a 6.5% return. Assuming the investor's primary goal is to maximize their return in US dollars, under which of the following exchange rate scenarios would the US bond be the superior investment?
An investor is comparing a one-year US asset with a 4% return to a one-year South African asset with a 6.5% return. To make the US dollar return from the South African asset exactly equal to the return from the US asset, the South African rand would need to depreciate against the US dollar by approximately ____%. (Please provide your answer rounded to two decimal places).
Investment Advisor's Dilemma
Evaluating Investment Advice