Ignoring default risk differences what would make American i

Ignoring default risk differences, what would make American investors purchase foreign bonds when the U.S. interest rate is above the foreign interest rate?

Solution

When interest rates are high in US compared to foreign interest rates, ideally US investors should tend to purchase US bonds in search of higher returns.

But, at the same time, US investors would want to invest in foreign bonds in the following condition:

When US currency is expected to fall against the foreign currency.

Let us understand it with a simple example:

A US citizen has $100 to invest .

US Interest rate = 10%

Foreign Interest rate = 8%

Today currency 1$ = 2 Foreign currency units

After 1 year 1$ = 1.5 Foreign currency units

1 year returns after Investing in US bonds: (100) + ((1/10)*100) = $ 110

1 year return after investing in Foreign bonds: (200) + ((1/8)*200) = 216 foreign currency units. Converting it to US currency would return ((1/1.5)*216) = $144

Hence when domestic currency is falling, US investors might want to invest in Foreign Bonds rather than US bonds even though the rate of interest is higher in US as compared to foreign nation.