11 the return on the canadian bond is equal to the

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11. The return on the Canadian bond is equal to the sum of: coupon income + gain or loss from the premium or discount in the forward rate relative to the spot exchange rate + capital gain or loss on the bond. Over the six-month period, the return is: Coupon + forward premium/discount + capital gain = + + %) 75 . 0 ( 2 % 50 . 7 Price change in % = 3.00% + % capital gain The expected semiannual return on the U.S. bond is 3.25%. Since the U.S. bond is selling at par and its yield is expected to remain unchanged, there is no expected capital gain or loss on the U.S. bond. Therefore, in order to provide the same return, the Canadian bond must provide a capital gain of 0.25% (i.e., 1/4 point relative to par value of 100) over and above any expected capital gain on the U.S. bond. 12. a. We exchange $1 million for foreign currency at the current exchange rate and sell forward the amount of foreign currency we will accumulate 90 days from now. For the yen investment, we initially receive: 1 million/0.0119 = ¥84.034 million Invest for 90 days to accumulate: ¥84.034 × [1 + (0.0252/4)] = ¥84.563 million (Note that we divide the quoted 90-day rate by 4 because quoted money market interest rates typically are annualized using simple interest, assuming a 360-day year.) If we sell this number of yen forward at the forward exchange rate of 0.0120¥//dollar, we will end up with: 84.563 million × 0.0120 = $1.0148 million The 90-day dollar interest rate is 1.48%. Similarly, the dollar proceeds from the 90-day Canadian dollar investment will be: 0148 . 1 $ 7269 . 0 4 0674 . 0 1 7284 . 0 million 1 $ = × + × million The 90-day dollar interest rate is 1.48%, the same as that in the yen investment. 25-4
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b. The dollar-hedged rate of return on default-free government securities in both Japan and Canada is 1.48%. Therefore, the 90-day interest rate available on U.S. government securities must also be 1.48%. This corresponds to an APR of 5.92%, which is greater than the APR in Japan, and less than the APR in Canada. This result makes sense, as the relationship between forward and spot exchange rates indicates that the U.S. dollar is expected to depreciate against the yen and appreciate against the Canadian dollar. 13. a. Incorrect. There have been periods of strong performance despite weak currencies. It is also possible that an appreciating currency could enhance performance. b. Correct. c. Correct. d. Incorrect. Correlations are not stable over time. Also, the portfolio can move dramatically away from the efficient frontier from one period to the next. 14. a. The following arguments could be made in favor of active management: Economic diversity : the diversity of the Otunian economy across various sectors may offer the opportunity for the active investor to employ "top down" sector timing strategies.
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