Response to the following problem:
Letticia Garcia, an aggressive bond investor, is currently thinking about investing in a foreign (non-dollar-denominated) government bond. In particular, she's looking at a Swiss Government bond that matures in 15 years and carries a 9.5% coupon. The bond has a par value of 10 000 Swiss francs (CHF) and is currently trading at 110 (i.e. at 110% of par).
Letticia plans to hold the bond for a period of one year, at which time she thinks it will be trading at 117.5-she's anticipating a sharp decline in Swiss interest rates, which explains why she expects bond prices to move up. The current exchange rate is CHF1.58/A$, but she expects that to fall to CHF1.25/A$. Use the foreign investment total return formula introduced in Chapter 6 (Equation 6.6 on page 196) to answer the questions below.
a. Ignoring the currency effect, find the bond's total return (in its local currency).
b. Now find the total return on this bond in Australian dollars. Did currency exchange rates affect the return in any way? Do you think this bond would make a good investment? Explain.