partial foreign currency hedge and fully hedge interest, domestic, contract, currency

adehbone

Given a US investor, he invest in S&P and get domestic currency return of 5%, he also invest in UK and get UK pound return of 7%, spot rate=1.5 USD/Pound, US 1 year interest rate is 3% and UK 1 year interest rate is 4%, he short a one year pound Forward contract, with forward price 1.3 USD/Pound.

if fully hedged, what's the USD return for his UK market.

I think it is 7% (UK pound return), is it correct?

Windjam

He had a negative 7.4 return.

Example:

Take $500 and invest in UK market at 500 / 1.3 = 333 Pounds

Grows to 333 x 1.07 = 356 pounds in one year.

Uses forward to convert into $: 356 x 1.3 = $463

Loses 7.4%

mik82

if it is 80% hedged, how to calculate? under which circustance, we have partial hedge instead of fully hedged?

If it is fully hedged, I think it should be 7%+(1.3-1.5)/1.5=-6.3% instead of -7.4%

strikethree

linping85 Wrote:
-------------------------------------------------------
> if it is 80% hedged, how to calculate? under which
> circustance, we have partial hedge instead of
> fully hedged?
>
> If it is fully hedged, I think it should be
> 7%+(1.3-1.5)/1.5=-6.3% instead of -7.4%

I have never seen the total return being calculated like that. Currency return is always taken out after you have got the total return in US$

cityboy

Local Market Return = 7%

Futures return = (1.3-1.5)/1.5 = -13.33%

(1.07)(.8667) = .9274 - 1 = -7.26% return


80% hedge:

Currency return (assuming futures = spot at t1) = (1.3-1.5)/1.5 = -13.33%

Domestic return = .07-.1333(1.07) = -.0726 (same as 100% hedge since exchange rates behaved the same for spot and futures)

80% hedge return = -.0726-.8(-.1333) = .034

NO EXCUSES