Question

As portfolio manager of an international money market fund based in London, you seek high-interest earnings throughout the world for an aggressive fund that appeals to risk-neutral investors. Today, you seek to invest GBP 1,000,000 either at home or in the Ukraine. At present, the Ukrainian Hrywnja (UAH) is pegged to the U.S. dollar (USD) at UAH 3.1384/$1 and is not exchangeable for the GBP. Ukrainian time deposits maturing in 180 days yield 8.9% per annum, and those in the UK earn 4.2% per annum over the same time period. The current spot exchange rate is $1.582/GBP, and the 180-day forward rate is $1.5561/GBP. Given your investors’ risk preferences, should you invest at home or in the Ukraine (assume 360 days in one year, and zero transactions costs)? Is there any exchange rate risk if you choose the latter (Ukraine) investment? If, so explain its source.

Answer 1

If we invest in UK, the value after 180 days is 1000000*(1+4.2%/2)=1021000

If investing in Ukraine the value would be 1000000*(1+8.9%/2)*1.582*3.1384/(1.5561*3.1384) = 1061884.84

Clearly investing in Ukraine is more profitable. However the exchange risk is that of change in value of Ukrainian currency against dollar which might impact the gain