Jim Whitney | March 16, 2011 |
Comparing domestic and foreign returns in practice
Comparing annual rates of return on domestic and foreign 3-month government bonds, as of mid-October 1997: | ||||||||
U.S. interest rate: | 5.50% | |||||||
Britain | France | Germany | Japan | |||||
Interest rates (i*) | 7.19% | 3.32% | 3.40% | 0.48% | ||||
Covered interest arbitrage: | ||||||||
(1) Exchange rates (E & E*) | Pds/$ | $/Pd | Fr/$ | $/Fr | DM/$ | $/DM | Yn/$ | $/Yn |
Spot (s) | .6160 | 5.8610 | 0.1706 | 1.7475 | 121.1 | |||
3-mo. Forward (f) | .6184 | 5.8286 | 0.1716 | 1.7383 | 119.5 | |||
(2) Expected %DE* | 0.586% | |||||||
(3) Annual exp.%DE* | 2.34% | |||||||
(4) Overall U.S. annual return on foreign bonds | 5.66% | |||||||
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Uncovered interest arbitrage: | ||||||||
(1) Exchange rates (E & E*) | Pds/$ | $/Pd | Fr/$ | $/Fr | DM/$ | $/DM | Yn/$ | $/Yn |
mid-October 1997 | .6160 | 5.8610 | 0.1706 | 1.7475 | 121.1 | |||
mid-January 1998 | .6137 | 6.1365 | 0.1630 | 1.8320 | 129.8 | |||
(2) %DE* | -4.455% | |||||||
(3) Annual %DE* | -17.82% | |||||||
(4) Overall U.S. annual return on foreign bonds | -14.50% | |||||||
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Formulas: (1) E* = $/currency = 1/(currency per $) (2) %DE* = 100·((Ef* - Es*)/Es*) (3) Annual %DE* = 4·%DE* (4) Overall U.S. annual return on foreign bonds = i* + Annual %DE* |