Hello, could someone please provide an answer to the Institute solution on Q21 morning Question? Why is the ex-post dollar return: R(Dc)=R(Fc)+s+s*R(Fc) ? Why is s*R(Fc) included in the formula? I thought that the return is R(Dc)R(Fc)+s Thanks, sehens
Agree that the solution is kind of confusing. I did this and similar problem my way and every time it works, so you may find useful, assume US investor invest 1,000 exchange at the spot rate to get FC 1,000/1.724 = POUND 580.05 then invest pound at its risk free rate. 580.05\*1.0235 = 593.68. Then exchange pound back to 593.68*1.587 = 942.17. Finally compute ex-post return ($942.17/1,000) - 1 = -5.79%
I did exactly the same thing with YoYo111, also same assumption ($1,000). That’s the easiest way, no need to memorize.
Just think about it this way. Return on foreign bond is equal to the appreciation/depreciation in foreign currency plus the foreign bond’s interest rate. Simple as that…
thanks guys, does make sense - they curriculum never had an example like this as far as I remember. cheers
The real world practice example is the best for me 
finally i get it!!!
westibbs Wrote: ------------------------------------------------------- > Just think about it this way. Return on foreign > bond is equal to the appreciation/depreciation in > foreign currency plus the foreign bond’s interest > rate. Simple as that… Thats what we all know The answer has it as depreciation in FC + Foreign Interest rate + (depreciation*foreign interest rate) we are confused as to why the last term in brackets is mentioned And specially because the answer with and without the term in brackets comes very close
did anyone else understand the $/pound 1.724 method of displaying the exchange rate? I thouh it was $1 USD buys 1.724 GBP until the question said it changed to 1.587… super confusing.
Extra term comes from exact formular, not linear aproximation as westibbs said and most of us think about. This term is small though: R(Dc) = (1 + R(Fc))*(1 + s) -1 = R(Fc) + s + s*R(Fc) s is apr/depr of the foreign currency
I think the correct answer should be: return on uk bond + fcrp 2.35 + ((1.587/1.724)-1) I’m going with this. The answer was close enough.
Btw what is ex post?
as an approx it did work in this question… but NOT using FCRP…that’s the change in the spot exchange rate you just wrote in the formula… to get fcrp you need to subtract the inflation differential too
ex-ante before, ex-poste after (realized) i just think of poker… need to ante up before you play…
The approximate answer is return on UK Bond + Appreciation of the UK Pound. The more appropriate answer is (1+return on UK bond)(1+appreciation of UK Pound) - 1. When you expand the formula above you get the following. (1 * 1 +1 * appreciation of UK pound + return on UK bond * 1 + return on UK bond * appreciation of UK Pound) - 1. The first positive 1 and the last negative 1 cancel each other leaving us with the formula given on the mock answer sheet.
Ahhhh multplying the two gives you the precise solution… I was wondering why simply UK rate + change in spot gave such a close answer but not the right one… thank you!!