20 May ARE THE DIFFERENCES IN RATES OF RETURN IN (D) CONSISTENT WITH THE UNCOVERED INTEREST PARITY CONDITION?
Consider two bonds, one issued in euros in
Germany, one issued in Australian dollars in Australia. Assume that both
government securities are one-year bonds—paying the face value of the bond one
year from now. The exchange rate, E, stands at 1A$ = 1.05 Euros.
The face values and prices on the two bonds are given by
Face
Value Price
Australia 1-year bond A$10,000 A $9,615.38
Germany 1-year
bond €13,333 €12,698.10
The symbol € represents the euro.
a. Compute the nominal interest
rate on each of the bonds.
b. Compute the expected exchange
rate next year consistent with uncovered interest parity.
c. If you expect the A$ to
depreciate relative to the Euro, which bond should you buy? Why?
d. Assume you are an Australian
investor. You exchange A$ for euros and purchase the German bond. One year from
now it turns out E is actually 1.11 (1A$ = 1.11 euros). What is your realized
rate of return in A$ compared to the realized rate of return you would have
made had you held the Australian bond?
e. Are the differences in rates of
return in (d) consistent with the uncovered interest parity condition? Why or
why not?
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