Letticia Garcia, an aggressive bond investor, is currently thinking about investing in a foreign (non-dollar-denominated) government bond. In particular, she’s looking at a Swiss government bond that matures in 15 years and carries a coupon of
8.81 %. The bond has a par value of 14,000 Swiss francs (CHF) and is currently trading at 105.05 (i.e., at 105.05% of par). Letticia plans to hold the bond for a period of 1 year, at which time she thinks it will be trading at 114.01. she’s anticipating a sharp decline in Swiss interest rates, which explains why she expects bond prices to move up. The current exchange rate is 1.61 CHF/U.S.$, but she expects that to fall to 1.24 CHF/U.S.$. Use the foreign investment total return formula to find the following information.
a. Ignoring the currency effect, find the bond’s total return (in its local currency).
b. Now find the total return on this bond in U.S. dollars. Did currency exchange rates affect the return in any way? Do you think this bond would make a good investment? Explain.