Question

1. The interest rate in the Euro area is 4%;

2. The interest rate in Japan is 2%;

3. The current nominal exchange rate is 165 (€1 = 165 Yen);

4. The expected nominal exchange rate next year is 155.

Using the information above answer the following question:

Ignoring risk and transaction costs, should a French resident prefer to invest in Euro-area or Japanese bonds?

Select one:

a.The French resident does not have enough information to make a decision

b.The French resident would be better investing in Euro Bonds

c.The French resident would be better investing in Japanese Bonds

d.The French resident would be indifferent between Japanese and Euro Bonds

Answer 1

A French resident should prefer to invest in Japanese bonds due to the expected depreciation of the Euro against the Yen.

Step-by-step explanation:

To determine whether a French resident should invest in Euro-area or Japanese bonds, we need to compare the interest rates and the expected exchange rate.

1. The interest rate in the Euro area is 4%, while it is 2% in Japan.

2. The current nominal exchange rate is 165 (€1 = 165 Yen), and the expected nominal exchange rate next year is 155.

Based on this information, the French resident would be better off investing in Japanese bonds. Even though the interest rate in the Euro area is higher, the expected depreciation of the Euro against the Yen would result in a higher return for the Japanese bonds. Therefore, option c. The French resident would be better investing in Japanese Bonds is the correct answer.