Question

Baalar, a U S company, invests $10,000,000 New Zealand dollar at a nominal interest rate of 10 percent. At the time the investment is made, the spot rate of the NZ$ is $ .63. The spot rate of the NZ$ at maturity of the investment is $0.61. (1) Calculate the effective yield of investing in the NZ$ (2) Would the effective rate be higher or lower if the spot rate at maturity were $0.65?

Answer 1

(a) Foreign investment return = 10%

Foreign currency returns (%) = 0.61 / 0.63 -1 = (-3.1746%)

Effective yield of investing in the NZ$ = (1 + Foreign investment return) x (1 + foreign currency return) - 1

Effective yield of investing in the NZ$ = (1 + 10%) x (1 + -3.1746%) - 1

Effective yield of investing in the NZ$ = 6.51%

(b) effective rate be higher if the spot rate at maturity were $0.65 since foreign currency returns would have been positive if spot at maturiy is $0.65

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