While in the managerial training program for a large multinational corporation, Daniel Waite is assigned a one-year rotation in the Mediterranean. Upon arriving at the assignment, he purchases a local (foreign currency) bond with an annual coupon of 8.5 percent for 96.5. He holds the bond for one year and then sells it for
98.0. Waite is pleased with his return, which he calculates at 10.4%.
On the plane ride home, Waite is seated next to his fellow coworker, Penny King, who begins to talk about the depressed local economy and the negative returns she had experienced on her local bond investments over the same period as Waite. She states that her total dollar return on an 8.0 percent annual coupon bond purchased at the same time as Waite's for 95.0 and sold for 98.0 (at the same time as Waite's) was a disappointing negative 10.737%.
Assume that King's calculation is correct and that Waite made some calculation error. Which of the following is closest to Waite's actual total dollar return?
Click on the arrows to vote for the correct answer
A. B. C. D.Explanation
Waite forgot to take into account the impact of the percentage change in the dollar value of the foreign currency.
Using the information provided by King, we can calculate the percentage change in the value of the foreign currency and then calculate Waite's total dollar return.
Using the formula for total dollar return of:
R$= { [ 1+($coupon + VEND- VBEG)/ VBEG] * (1 + g) } - 1,
-0.10737= { [ 1+(8.0 + 98.0 "" 95.0)/95.0 ] * (1 + FChange) } - 1
-0.10737 = { [1.115789] * (1 + FChange) } - 1
-0.2000 = FChange, or 20.0% depreciation.
Now, we can calculate Waite's total dollar return.
R$ Waite= { [ 1+(8.5 + 98.0 - 96.5)/96.5 ] * (1 - 0.20) } - 1
R$ Waite= -11.712%