Suppose that on July 1, 2016 a U.S. pension fund invested $100 millions in 1-year Certificate of Deposits (CDs) from country B. These CDs are denominated in BPounds. Suppose also that these CDs offered a nominal (in terms of B-pounds) interest rate of 5%. Suppose also that the exchange rate at that time was $2.32 per B-pound.
a) The exchange rate a year later, on July 1, 2017, was $2.57 per B-pound. What rate of return, in terms of nominal dollars, did the fund earn on its investment? (Note: a specific numeric answer is required. Please show the steps of your calculations.).
b) What would have been the return on the investment if the exchange rate on July 1, 2017 had been $2.20 per B-pound? Which exchange rate does the U.S. pension fund manager prefer? Explain your answer.