Suppose the CFO of a British corporation with surplus cash flow had 40 million pounds sterling to invest last March 20, 2016 and the corporation did not believe it would need to utilize these funds to retool or expand production capacity for 1 year. Suppose further that the interest rate on 1-year CD deposits in US banks was 1%, while the rate on 1 year CD deposits in England (denominated in British Pounds) was 1.5% at the time. Suppose further that the exchange rate at that time was $1.50 per British pound. Assume that the CFO of the British company invests in US CD deposits and holds them until maturity 1 year later.
Question) Suppose that now a year later the exchange rate is $1.40 per British pound. What rate of return did the CFO earn on the investment in the British CD? (Note: a specific numeric answer is required)
A) The CFO must have expected the amount of depreciation of British pound more than comparing to US dollar over the year to believe in March, 2016 that investment in 1 year US CD’s would be more profitable than the investment in British CD’s.