While serving as visiting conductor at the University of Edinburgh, U.S. Citizen William Golson purchases a 9.0 percent annual coupon bond denominated in the local currency for 93.0. One year later, before his return to the U.S., he sells the bond for 99.5. Using a holding period return formula he remembers from his undergraduate studies, he calculates his return at 16.7 percent. On the flight home, he is seated next to Kristin Meyer, CFA. She is puzzled because she has heard that similar investments yielded negative returns over the same time period. After consulting her financial newspaper, she recalculates Golson’s return at a disappointing negative 5.2 percent. Assuming Meyer is correct, which of the following statements is the most likely reason for the difference in the calculated returns? Golson: A) forgot to include the impact of foreign currency appreciation in relation to the dollar. B) made a computational error. C) omitted the impact of inflation. D) forgot to include the impact of foreign currency depreciation in relation to the dollar.
haha, ditch, this is crazy. i wont be surprised if we got the SAME score on Level 1.
Well, we’re either really good or really bad! All I know is I need to get my sleep schedule in line over the next week. These late nights on the weekends kill me during the day.
Answer: D Golson most likely forgot to take into account the impact of the percentage change in the dollar value of the foreign currency. Here, since the correct return (calculated by Meyer) is lower than that calculated by Golson (who omitted the impact of foreign exchange), the foreign currency depreciated in relation to the dollar. The appreciation in the bond value was not enough to offset the currency depreciation, and the total return in dollar terms was negative. Calculating the total dollar return on a bond is discussed in more detail later in Study Session 18.
“the foreign currency depreciated in relation to the dollar” How on earth are we supposed to know that from the given information? It could’ve gone either way.
I don’t get it, why would currency depreciation effect a foreign bond bought/sold in a foreign currency?
Since he is a US Citizen, he cares about dollar returns, and purchasing a foreign bond means forex risk needs to be considered. But like I said, it could’ve gone either way…
chad17 Wrote: ------------------------------------------------------- > “the foreign currency depreciated in relation to > the dollar” > > How on earth are we supposed to know that from the > given information? It could’ve gone either way. I don’t follow. If currency appreciates relative to dollar, doesn’t he underestimate the return?