Suppose you purchase a 10-year, AAA-rated Swiss bond for par that is paying an annual coupon of 6 percent. The bond has a face value of 1,000 Swiss francs (SF). The spot rate at the time of purchase is SF1.50/$. At the end of the year, the bond is downgraded to AA and the yield increases to 8 percent. In addi- tion, the SF appreciates to SF1.35/$.

a. What is the loss or gain to a Swiss investor who holds this bond for a year? What portion of this loss or gain is due to foreign exchange risk? What por- tion is due to interest rate risk?

b. What is the loss or gain to a U.S. investor who holds this bond for a year? What portion of this loss or gain is due to foreign exchange risk? What por- tion is due to interest rate risk?