UK/C$ Spot = 0.4 UK risk free = 6% UK expected inflation = 4% Cdn risk free = 9% Cdn expected inflation = 7% The ratio of the price of the UK consumption basket to the CDN consumption basket is 0.3 Suppose ABC adds slapshot Inc. stock to several client portfolios. He purchased the stock at C$100.00. One year later, the stock is trading at C$122. There were no dividend payments during the year. The real ex. rate at yr end is 1.41. The domestic current (i.e. UK) return for ABC’s clients is closest to: A) 6.51 % B) 16.32 % C) 17.37% D) 24.79%
D? UK Inflation = 0.3 * 1.04 = .312 CDN Inflation = 1.07 Excange Rate = 1.41 * .312 / 1.07 = 0.411 Return = 122 * . .411 - 100 * .4) / 40 = 25.05. The closest is D.
D at the beginning of year, real rate=0.4/.3=1.33 GBP/CAD<1.41 by the end, real FX rate>beginning, so CAD has appreciated in real term, i.e. return in GBP> return in CAD return in CAD=22% D is the only choice
D Beg Nominal Exchange = 0.4 UK/C$ DC = UK FC = C$ Real Exc = Nom Exc* P(FC) / P(DC) Thus Nom Exc = Real Exc* P (DC) / P(FC) End Nom Exch = 1.41 *(0.3(1.04)/1.07) where 1.04 and 1.07 are the inflation factors End Nom Exch = 0.4111 % Change in Nom Rate = (.4111/4) -1 = 2.79% %HPR = (122/100) - 1 = 22% Total Return = 22%+2.79% = 24.79%