Question
Each of the governments of Brazil and Turkey has issued bonds in Brazilian real (BRL) and Turkish lira (TRY), respectively. Assume that both government securities
Each of the governments of Brazil and Turkey has issued bonds in Brazilian real (BRL) and Turkish lira (TRY), respectively. Assume that both government securities are one- year bonds, i.e., paying the face value of the bond one year from now. Suppose that the exchange rate, E, stands at 1 Brazilian real per 0.79 Turkish lira. The following table gives face values and prices of both bonds:
face value price
brazil brl 10000 brl 9630
turkey try 10000 try 9450
a. Compute the nominal interest rate on each of the bonds. b. Compute the expected exchange rate next year consistent with uncovered interest parity. c. If you expect the real to depreciate relative to the lira, which bond should you buy? d. Assume that you are a Brazilian investor. You exchange the reals for liras and purchase the Turkish bond. One year from now, it turns out that the exchange rate, E, is 0.75, i.e., 0.75 liras buy one real. What is your realized rate of return in reals compared to the realized rate of return you would have made had you held the Brazilian bond? e. Are the differences in rates of return in part d consistent with the uncovered interest parity condition? Explain your answer.
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