Suppose that on July 1, 2015 a U.S. pension fund invested $100 millions in 1-yea

Question

Suppose that on July 1, 2015 a U.S. pension fund invested $100 millions in 1-year Certificate of Deposits in England. These CDs are denominated in British Pounds. Suppose also that these CDs had an interest rate of 10% then. The exchange rate at that time was $1.56 per British pound.

a) The exchange rate a year later, on July 1, 2016, was $1.33 per British pound. What rate of return did the fund earn on its investment in English CDs? (specific numeric answer with steps will be helpful please).

b) On June 23, 2015, few days before the maturity date of the deposit, the exchange rate was $1.48 per British pound. What would have been the return on the investment using this exchange rate? Note that the $/UK pound exchange rate on July 1 of this year was lower than few days before because Great Britain voted to leave the European Union. This event had the British pound fall. Do you think that the U.S. pension fund manager was happy about the outcome of the vote? Explain why.

Explanation / Answer

Rate of return on English CDs

Step 1. Conver $100 Millions in British Pound = 100/1.56 = 64.1026 Millions British Pound

Step 2. Earn 10% on British Pound, Value of British Pound = 64.1026 * 1.10 = 70.51286

Step 3. Convert British Pound in $ a year Later = 70.51286 * $1.33 = 93.7821 Millions $

ROR = (93.7821 - 100) / 100 = - 6.2179%

B) No, U.S. pension fund manager was not happy about the outcome of the vote cause decrese in Pension Fund

Based on Step 3 Above expected Return on 23 June is

Step 3. Convert British Pound in $ on 23 June = 70.51286 * $1.48 = 104.3590 Millions $

ROR = (104.3590 - 100) / 100 = 4.359%

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