Exercise 5 Consider two bonds, one of them Spanish, denominated in euros (h), and the other denominated in Chilean pesos ($), a Chilean bond. Assume both bonds have a 1-year maturity and that they are negotiated with discount, in other words, they pay a determined value per maturity and have a current price equal to a fraction of the amount paid at maturity. The current exchange rate is S 5 2.5 $/h. The face value of the Chilean bond is $1,000.00, while the face value of the Spanish bond is h1,000.00. The market price for the Chilean bond on date t is $956,00 and the market price for the Spanish bond is h945,00.

a. What is the nominal interest rate for each of the bonds?

b. Find the expected exchange rate at bond maturity that is compatible with the uncovered interest rate parity.

c. If you expect there will be a short-term appreciation of the Chilean peso against the euro, which of the bonds should you buy?

d. Suppose you are a Chilean investor who is considering exchanging pesos for euros to purchase the Spanish bond. One year later the exchange rate will be S 5 2.3 $/h. What is the rate of return measured in pesos? Compare to the rate of return you would have received by investing in Chilean bonds.

e. Are the differences in returns obtained in the previous question compatible with the uncovered interest rate parity? Explain your answer.

56 PRINCIPLES OF INTERNATIONAL FINANCE AND OPEN ECONOMY MACROECONOMICS