Question

Your client has been offered a money market security with a par value £ 1000 that matures in one year in the UK market. The current price on the market is £ 946. The current exchange rate (S0) is 1.46 $/£. You also know that one year from now the exchange rate will be at 1.44 $/£. What is the effective yield of this security if your client holds the bond until maturity? For example, if you find that effective interest rate is 5.28 percent, type "5.28" in the box

Answer 1

Given the current price = £ 946

Dollars required to day to buy this money market security is 946 * 1.46( Given the spot rate is 1.46 $/£.)

= $1381.16

1 year from now the bond matures and our client gets the £1000 par value

Hence the dollar inflow will be 1000 * 1.44 = 1440

Given after 1 year the rate is 1.44 $/£

Hence initial dollar outflow = $1381.16

After 1 year the dollar inflow = $1440

Hence the profit we got = 1440 - 1381.16 = $58.84

Return on our dollar investment or effective investment yeild= 58.84/1381.16 = 4.26%