jmh530

1. You hedge with forward contracts and the forward rate will be based on the interest rate differential. In this case, the interest rate differential is 0.7%.

So, your hedged return if you are the British fund will be 4.7% (you can lock in a forward contract to guarantee a rate of return of 4.7%) If you do nothing (i.e., pick up 4% on the U.S. rate plus 0.4% on the U.S. currency appreciation) your return will only be 4.4%, less than the hedged return of 4.7%.