Question

You are an investment manager in Chile. You see different interest rates around the world and your exchange trading team has provided you with the current spot rate and an expected future spot rate between the Chilean and Hong Kong currencies.

*Current spot exchange rate is 86 Chilean Pesos per Hong Kong Dollar
*The 1 year interest rate on the Hong Kong Dollar-denominated bank deposit is 2.5% *The 1 year interest rate on the Pesos-denominated bank deposit is 5.0%
*Expected future spot rate in 90 days is 90 Chilean Pesos per Hong Kong Dollar

Where will you earn the higher rate of return – Chile or Hong Kong?

(Answer is Hong Kong, I need an explanation. We are given this equation:

Expected Uncovered Interest Differential (EUD) = ((future spot rate - current spot rate)/(current spot rate)) + (foreign interest - domestic interest)

Answer 1

Expected Uncovered Interest Differential (EUD) = ((future spot rate - current spot rate)/(current spot rate)) + (foreign interest - domestic interest)=((90-86)/86)+(2.5%-5%)*90/365=4.0347244%
As EUD is positive, invest in Hong Kong for higher returns

Alternative:
Lets say you are based out of Chile
Borrow 86 Chilean Pesos at 2.5%
Convert to 1 Hong Kong Dollar and invest at 5%
Peso Return=1*90*(1+2.5%*90/365)-86*(1+5%*90/365)=3.494520548 Chilean Pesos
Hence, If one invests in Hong Kong by borrowing in Chile, he will earn a higher rate of return