Question

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 face values and prices on the two bonds are given by Face Value $10,000 10,000 Price $9,615.38 €3,345 79 United States Germany Compute the nominal interest rate on each of the bonds. bond-||% Nominal interest rate on the US (Enter your response es a whole number.) Nominal interest rate on the German bond% (Enter your response as a whole number.) The exchange rate, E, stands at S1 0.79 Compute the expected exchange rate next year consistent with uncovered interest parity. The expected exchange rate next year with uncovered interest parity isES (Round your response to two decimal places) If you expect the dollar to depreciate relative to the euro, which bond should you buy? You should buy the bond.

Answer 1

r= [(FV/PV)^(1/n) -1 ] * 100

r(US) = [(10000/9615.38)^1 -1]*100 = (1.04 -1)*100 = 4%

r(GER) = [(10000/9345.79)^1 -1]*100 = (1.07-1)*100 = 7%

Future Exchange rate (USD/EUR)= Current Rate (USD/EUR) * (1+ r(US))/(1+r(GER))= 1/0.79 * 1.04/1.07 = 1.23

=> One year from now 1 USD = 1.23 Euro

If USD Depreciates relative to Euro.Dollar should be bought as nominal rates will increase for it and decline for Euro.