Question

Assume that the U.S. one-year interest rate is 3 percent and the one-year interest rate on Australian dollars is 6 percent. The U.S. expected annual inflation is 5 percent, while the Australian inflation is expected to be 7 percent. You have $100,000 to invest for one year and you believe that PPP holds. The spot exchange rate of an Australian dollar is $0.689. What will be the yield on your investment if you invest in the Australian market

Answer 1

Answer:

4%

Explanation:

you invest $100,000 today and purchase A$145,137.88

in one year, you will have A$152,394.78

since the PPP stands, the spot rate in one year should be:

0.703 US$ per A$ (since Australia's inflation rate is 2% higher than the US inflation rate, the Australian dollar will depreciate by 2%)

with your A$152,394.78, you can purchase $107,133.53

if you invested in the US instead, you would have $103,000

this means that your Australian investment yielded ($107,133.53 / $103,000) - 1 = 0.04 or 4%