You are an American resident but have invested in a German bond (paying face value) that matures in two years, pays a 5 percent interest rate and is denominated in euros. What could cause your rate of return to fall below 5 percent even though the bond pays off at maturity?
What will be an ideal response?
The exchange rate at the time the bond matures is not the same as the exchange rate when the bond was purchased. For example, let's say that at the time the bond was purchased it carried a face value of 1,000 euros and the exchange rate was 1euro/dollar. If the exchange rate remained constant you would have a 5 percent return. But if the exchange rate changes, to say 1.05 euros/dollar, the return on the bond for you is zero (0).
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