Answer to Question #65145 in Finance for Luisa

Question

Put yourself back in September 1993. Brazilian bond was paying a monthly interest rate of 36.9 percent. U.S. bond was paying monthly interest rate of 0.2 percent. The observed rate of appreciation of dollar against cruzeiro (the currency of Brazil at that time, now its currency is called real) in August was 34.6 percent. If we use this rate as the expected rate of appreciation for September, what are the expected one-month dollar rates of return on U.S. and Brazilian bond, respectively? Does the UIP hold in this case? If not, why?

Answer 1

If Brazilian bond was paying a monthly interest rate of 36.9 percent and U.S. bond was paying monthly interest rate of 0.2 percent, but the observed rate of appreciation of dollar against cruzeiro was 34.6 percent, then the expected one-month dollar rates of return on U.S. and Brazilian bond are 0.2% and 36.9 - 34.6 = 2.3% respectively.