Question

As a Canadian Saver, you intend to invest $50,000 in one of the three investments described below. The world risk-free rate is 1%. There is a 2% risk-premium on the Canadian discount bond but a Brasilian discount bond has a risk-premium of 6%. The current nominal Cad-Brasilian exchange rate is eCAD = 3 (Reals per Cad dollar). Before the pay-out next period, you expect the Real to depreciate relative to the Cad$ to a new nominal exchange rate, efuture = 4. Your third alternative is to buy a condo in Florida. The current nominal US-Cad exchange rate is eUS = 1.333 ($Cad per U.S. dollar). You expect the condo to increase in resale value by 20% but you also forecast the Cad dollar to rise to eUS = 1.25. Based on your forecast, what is the expected rate of return (% yield) on each investment (correct to one decimal place is fine)? For simplicity assume zero transaction costs.

% return on Cad Bond: _______

% return on Brasilian Bond: _______

% return on Florida Condo: _______

Answer 1

% return on Cad Bond

% return on Cad Bond = Risk free rate + Risk premium = 1% + 2% = 3%

% return on Brasilian Bond:

BRASILIAN REAL = 50000 * 3= REAL 150,000

Return on Brasilian discount bond = Risk free rate + risk premium = 1% + 6% = 7%

Amount in Real after one year = 150000 * (1 + 7%) = REAL 160,500

Amount in CAD after oner year = 160500 / 4 = CAD 40,125

% return on Brasilian Bond = (40125 / 50000) - 1 = (19.75%)

% return on Florida Condo:

CAD 50000 = USD 50000/1.33 = USD $37593.98

With  increase in resale value by 20% amount in USD will be = 37593.98 * 1.20 = USD 45112.78

Amount after one in CAD = 45112.78 * 1.25 = CAD 56390.98

% RETURN = 56390.98 / 50000 - 1 = 12.78%

Hence:

% return on Cad Bond = 3%

% return on Brasilian Bond = (19.75%)

% return on Florida Condo = 12.78%