Suppose that you are an Israeli citizen and had invested in a one-year U.S. bond that yielded 5 percent. The bond cost $5,000 and paid $5,250 at the end of the year. At the time you bought the bond, the exchange rate was 3.8 shekels/dollar. How many shekels did the bond cost? If the exchange rate fell to 3.5 shekels/dollar over this time period, what would the return on your investment be?
What will be an ideal response?
The bond cost 19,000 shekels and would have returned 19,950 shekels at the end of the year had the exchange rate stayed constant. However, at the end of the year, your investment was worth 18,375 shekels, so your effective rate of return on the investment was -625 / 19,000 = -3.3 percent.
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