OZ Bank in Australia borrows from local capital market and invests in one-year U.S. treasury bond. The interest rate in Australia is 5% per annum. And the yield to maturity of the invested U.S. treasury bond is 10% per annum. Currently, the spot exchange rate is AU$1.1 per US$. What will be the NET return in local currency (AU$) of this investment to the bank if the exchange rate falls to AU$1 per US$ in one year? (round to the nearest 2nd decimal)

Question

BlackTom AI · Accepted Answer

To begin, restate the scenario and the numbers involved to keep track of cash flows clearly. OZ Bank borrows 1.10 AU$ (the amount needed to invest in 1 US$ at the current spot of 1.1 AU$/US$) and uses it to buy 1.00 US$ worth of a one-year US Treasury, which yields 10% over the year. The spot exchange rate today is AU$1.10 per US$, and at the end of the year the rate falls to AU$1.00 per US$.

First, determine the dollar cash inflow from the US bond in USD terms. An investment of 1.00 USD at a 10% yield grows to 1.00 × (1 + 0.10) = 1.10 USD after one year.

Second, convert that USD payoff back to Australian dollars using the expected future exchange rate. If the rate falls to AU$1.00 per US$, then 1.10 USD equals 1.10 × 1.00 = 1.10 AU$.

Third, figure out the loan repayment in AU$. The bank borrowed 1.10 AU$ at 5% interest, so the amount owed after one year is 1.10 × (1 + 0.05) = 1.155 AU$.

Fourth, compute the net AU$ cash flow at year end by subtracting the AU$ loan repayment from the AU$ payoff from the investment: 1.10 AU$ − 1.155 AU$ = −0.055 AU$.

Fifth, assess the net return relative to the initial AU$ investment. The initial investment in AU$ was 1.10, so the return rate is −0.055 / 1.10 = −0.05, i.e., −5.00%.

Putting it together, the calculated net return in AU$ is −0.055 AU$, which corresponds to a −5.00% return when rounded to two decimals. Among the given options, this matches the option that shows −5.00%.

Similar Questions

An American manufacturer with its corporate headquarters in New York City is purchasing goods from a French supplier. Which of the following statements is true regarding the exchange rate risk for this contract?

An Indonesian student’s family purchased an apartment for AUD 1 million in the Melbourne CBD area for their son to stay in during his study at Monash College. The contract will be settled in 6 months. Which of the following statements is true regarding the exchange rate risk for the family?

An American manufacturer with its corporate headquarters in New York City is purchasing goods from a French supplier. Which of the following statements is true regarding the exchange rate risk for this contract?

An Indonesian student’s family purchased an apartment for AUD 1 million in the Melbourne CBD area for their son to stay in during his study at Monash College. The contract will be settled in 6 months. Which of the following statements is true regarding the exchange rate risk for the family?

A Japanese manufacturer with its corporate headquarters in Tokyo is purchasing goods from a French supplier. Which of the following statements is true regarding the exchange rate risk for this contract?

An American manufacturer with its corporate headquarters in New York City is purchasing goods from a French supplier. Which of the following statements is true regarding the exchange rate risk for this contract?

An American manufacturer with its corporate headquarters in New York City is purchasing goods from a French supplier. Which of the following statements is true regarding the exchange rate risk for this contract?

More Practical Tools for Students Powered by AI Study Helper

Homework AI Solver

Stylized AI Paper Writer

Plagiarism Checker Assistant

Citation AI Academic Writing Tool

In-Class Translation Assistant

AI Note Generator

AI Quiz Answers

Past Exam Questions from University Test Bank

Smart Practice Assistant

Adaptive Practice

Making Your Study Simpler