Question

The current dollar-pound exchange rate is $1.50 to £1.00. Suppose the annual interest rate of a U.S. bond is 5% while the annual interest rate of a British bond is 7%. You have $1,500 and want to purchase a £1,000 British bond now. How much U.S. dollars would you receive after a year, assuming the exchange rate remains at $1.50 to £1.00.

PLEASE SHOW ALL WORK AND BE THOROUGH

Answer 1

see had you invested your money in US then with 15oo dollar you would have got 1500+ 1500*5/100 = 1500+75 = 1575 dollars. basic maths is used here as it is given that interest rate is 5% in US

now you equated 1500 dollars to 1000 pounds and invested in UK.

In UK rate of interest is 7% that means a person investing 1000 pounds , after a year , will get 1000 + 1000*7/100 = 1070 pounds.

now convert this amount to dollars at the exchange rate of 1.5 dollars per pound.

one pound = 1.5 dollars

so 1070 pounds = 1070 *1,5 = 1605 dollars

So by investing in UK and not investing in US a person earns 1605 dollar- 1575 dollar = 30 dollar extra.

Hope this helps.