John Stanley, a US investor based in New York, is considering a three-year investment on zero-coupon government bonds. Currently, the annual yield to maturity of US, German and Chinese zero-coupon government bonds maturing in three years is 2%, 3% and 5%, respectively. The spot exchange rate between the US dollar and the euro is $:€ = 0.80, while between the US dollar and the Chinese yuan is $:CNY = 6. According to John’s forecasting models, the spot exchange rates are expected to be $:€ = 0.87 and $:CNY = 6.80 in three years from today.

i) Which of the three bonds would provide the highest cumulative return for John over the next three years, if the exchange rate forecasts turn out to be correct? In answering this question explain all your workings in detail.

ii) What is the dollar to yuan exchange rate (three-year) forecast that would make John indifferent between investing in either the US or the Chinese bond today? In answering this question explain all your workings in detail.