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Suppose an investment fund manager considers investing $10,000,000 either in one-year (1Y) US Treasury note or in a corresponding UK Government one-year bond (UK 1Y Gilt). The UK investment would be covered with a one-year forward contract. The current yield on a 1Y US Government bond was 0.13% (+0.0013), while the yield on a 1Y UK bond was -0.02% (-0.0002) on October 7, 2020 (at 3:50pm EST, Bloomberg data). The GBP in USD spot rate was 1.2918 and the 1Y forward rate was 1.2948.
(a) Compute the one-year USD return on investment in the US Government bond.
(b) Compute the one-year USD return on investment in the UK Government bond, adjusted for the forward to spot rate ratio.
(c) Which of the two investment alternatives is more profitable? Explain why.
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