Monsieur Dassault, the treasurer of Renault-Finance S.A.-the Genevabased international finance subsidiary of the French automobile manufacturer-was intrigued by the apparently high yield offered by South African government bonds. Specifically, he could purchase rand-denominated ESCOM bonds (issued by the government-owned Electricity Supply Commission)

at par which pay an 11 % coupon in two equal half-yearly installments. The transaction would have to be channeled through South Africa's two-tier exchange market: nonresident investors in South African bonds have to contend with a system of two different exchange rates that allows for investment (and divestment)

to be made through the financial tier, whereas interest payments are repatriated through the commercial tier. On July 19, 1989, the commercial rand was worth

$.38 while the financial rand traded at $.24. The central bank traditionally stabilizes the commercial rand while it allows the financial rand to fluctuate.

a) What is the effective rate of return on Rand 25 million uncovered investment, assuming that the investment is liquidated after one year?

b) Assuming a 6 % discount on financial rand, compute the effective yield on an uncovered investment of Rand 25 million, assuming that the investment is liquidated after one year.

c) Discuss credit risk, exchange risk, interest rate risk, and country risk faced by nonresident investors in ESCOM bonds.

d) Compute the break-even exchange rate on the fmancial rand if RenaultFinance is comparing its ESCOM investment with similarly risky dollardenominated high-yield bonds offering a coupon of 12 7/8 %. Sketch graphically your analysis.