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CFAns 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
CFAns 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 pesodenominated bond, the investment goal is to achieve the highest holding period return, measured in US dollars, on the investment.
Davies finds the higher yield on the Mexican oneyear 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 US dollars. Hamson has prepared selected economic and financial data to help Davies make the decision.
Selected Economic and Financial Data for US and Mexico
Expected US Inflation Rate
Expected Mexican Inflation Rate
US Oneyear Treasury Bond Yield
Mexican Oneyear Bond Yield
per year
per year
Nominal Exchange Rates
Nominal Exchange Rates
Pesos $
Pesos $
Hamson recommends buying the Mexican oneyear bond and hedging the foreign currency exposure using the oneyear forward exchange rate. She concludes: "This transaction will result in a US dollar holding period return that is equal to the
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holding period return of the US oneyear bond."
Hamson recommends buying the Mexican oneyear bond and hedging the foreign currency exposure using the oneyear forward exchange rate. She concludes: "This transaction will result in a US dollar holding period return that is equal to the holding period return of the US oneyear bond."
a Calculate the US dollar holding period return that would result from the transaction recommended by Hamson. Show your calculations. State whether Hamson's conclusion about the US dollar holding period return resulting from the transaction is correct or incorrect.
After conducting his own analysis of the US and Mexican economies, Davies expects that both the US inflation rate and the real exchange rate will remain constant over the coming year. Because of favorable political developments in Mexico, however, he expects that the Mexican inflation rate in annual terms will fall from percent to percent before the end of the year. As a result, Davies decides to invest Yucatan Resort's cash holdings in the Mexican oneyear bond but not to hedge the currency exposure.
b Calculate the expected exchange rate pesos per dollar one year from now. Show your calculations. Note: Your calculations should assume that Davies is correct in his expectations about the real exchange rate and the Mexican and US inflation rates.
c Calculate the expected US dollar holding period return on the Mexican oneyear bond. Show your calculations. Note: Your calculations should assume that Davies is correct in his expectations about the real exchange rate and the Mexican and US inflation rates.
cessibility: Investigate
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