CFA PRO rR$$s After studying Iris Hamson's credit analysis, George Davies is considering whether he can increase the holding period return on Yucatan Resort's excess cash holdings $($which are held in pesos$)$ by investing those cash holdings in the Mexican bond market. Although Davies would be investing in a peso$-$denominated bond, the investment goal is to achieve the highest holding period return, measured in U$.$S$.$ dollars, on the investment.

Davies finds the higher yield on the Mexican one$-$year bond, which is considered to be free of credit risk, to be attractive but he is concerned that depreciation of the peso will reduce the holding period return, measured in U$.$S$.$ dollars. Hamson has prepared selected economic and financial data to help Davies make the decision.

Selected Economic and Financial Data for U$.$S$.$ and Mexico

Expected U$.$S$.$ Inflation Rate

$2\mathrm{.}0\%$ per year

Expected Mexican Inflation Rate

$6\mathrm{.}0\%$ per year

U$.$S$.$ One$-$year Treasury Bond Yield

$2\mathrm{.}5\%$

Mexican One$-$year Bond Yield

$6\mathrm{.}5\%$

Nominal Exchange Rates

Spot

$9\mathrm{.}5000$ Pesos $=$ U$.$S$.$ $$1\mathrm{.}00$

One$-$year Forward

$9\mathrm{.}5000$ Pesos $=$ U$.$S$.$ $$1\mathrm{.}00$

Hamson recommends buying the Mexican one$-$year bond and hedging the foreign currency exposure using the one$-$year forward exchange rate. She concludes: "This transaction will result in a U$.$S$.$ dollar holding period return that is equal to the holding period return of the U$.$S$.$ one$-$year bond."