Question

II. Consider two bonds, one issued in euros () in Germany, and one issued in dollars (S) in the United States. 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 0.75 euros per dollar. The face values and prices on the two bonds are given by Face Value $10,000 10,000 Pric S9,615.38 9,433.96 United States Germany 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 dollar to depreciate relative to the euro, which bond should you buy?

Answer 1

Answer:

To calculate the nominal interest rate on these bonds we will need to take the face value of the bond and divide it by the price This will give us a number larger than 1 To determine the nominal interest rate we will need to subtract 1 from this number that will give us a decimal telling us what the nominal interest rate is First, we will calculate the nominal interest rate on the bond that has a face value of $10,000 and a price of $ 9,615.38. x = $ 10,000/$ 9,615.38-1 x = 1.040-1 x = 0.04 or 4% The nominal interest rate on the bond is 4% Next, we will calculate the nominal interest rate on the German bond which has a face value of $ 10,000 and a price of $ 9,433 96. x = $ 10,000/ $ 9,433.96-1 x = 1.060-1 x = 0.06 or 6% The nominal