Final answer:
To calculate the expected rate of return from this international currency transaction, one must consider initial and ending exchange rates, the interest rate on borrowed currency, and the respective inflation rates of the countries involved, guided by the International Fisher's effect.
Step-by-step explanation:
The scenario presents a situation where one has borrowed Hong Kong dollars (HKD), converted them into U.S. dollars, and invested in the U.S. To calculate the expected rate of return, various factors need to be considered.
Initially, you borrowed HKD 100,000 when the exchange rate was HKD7/$. This equates to $14,285.71 (100,000 / 7). When the exchange rate changed to HKD8/$, your $14,285.71 would convert back to HKD 114,285.71.
However, you also need to consider the interest rate of 18% for borrowing HKD, which means you owe HKD 118,000 at the year's end. Considering the inflation rates for the U.S. (2%) and Hong Kong (9%), adjustments to the amounts to account for inflation would also need to be made according to the International Fisher's effect, which suggests that an expected rate of change in the exchange rate between two currencies is approximately the difference between their nominal interest rates minus the inflation rate differential.
The expected rate of return, therefore, can be calculated as the amount of HKD obtained at the year's end minus the borrowed amount, adjusted for the inflation in both the U.S. and Hong Kong. The calculation is more complex in practice, but the essence is that both the interest rate and inflation rate differentials play a crucial role in determining the final return when engaging in international investment or currency exchange.