The paper aims to estimate the rates of return on foreign portfolio investment in local money markets. The authors have limited their analysis mainly to the impact of exchange rate volatility and transaction costs (i.e. interest rate and exchange rate margins) on the performance of foreign portfolio investment in a short period of time (up to 1 year). The study is based on traditional money market instruments, including deposits and loans denominated in euros, zloties and US dollars, for standardised investment (interest rate) periods, offered at LIBOR (EURIBOR) rates on the eurodollar market, and at WIBID and WIBOR rates on the Polish market between 1998 and 30 September 2001. In order to make the calculation of the rates possible, it was assumed that foreign portfolio investment on the domestic market follows one of the two principal strategies. An investor may open a currency position in zloties, which entails borrowing eurocurrencies (e.g. eurodollars or euro) in the European market. The other investment strategy, seen from the perspective of the Polish market, involves opening the reverse currency position, i.e. obtaining a zloty loan and investing in eurocurrencies.

The results of the above empirical test show that high interest rates prevailing in Poland in the period under observation undoubtedly posed an incentive for speculative investment in Poland. Statistical analysis reveals a certain cyclicality of the return rate, under which periods of high losses alternate with periods of extraordinary profits. Although the decisions made by foreign investors when purchasing zloty-denominated money market instruments were determined by the interest rates (the WIBOR and LIBOR rates), they were also heavily influenced by the - not always justified - expectations as to the possible appreciation (depreciation) of the zloty versus the euro or the dollar in the short investment periods. Domestic zloty investors in turn, who might have invested in eurocurrencies in the European market by borrowing in zloties first, would certainly have incurred losses in almost all the periods analysed.

The analysis of the empirically observed rates of return in many successive investment periods between January 1998 and September 2001 shows that portfolio investors made obvious mistakes. Not only was it impossible for them to achieve the desired rewards (particularly with respect to one- and three-month investments); they suffered substantial losses as well. This disproves the notion that purchasing high interest short term assets denominated in the uncertain Polish currency will potentially always render high risk premiums and attractive rates of return.