currency movements and portfolio rate of return return

NakedPuts

Quiz time!

You invest in a fund denominated in euros. The fund's return for the period is 8%. The euro depreciates 2% vs your domestic currency. Div yield for the period is 1%. What is the portfolio's rate of return in your base currency for the period?

Giddy up.

NakedPuts00

Paraguay Wrote:
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> LobsterBoy Wrote:
> --------------------------------------------------
> -----
> > Here is perhaps an easier way to do it:
> > Rd= Domestic return
> > Rlc = Local currency return = Capital Gain +
> Yield
> > Income = .08 +.01 = .09
> > S = currency spot appreciation = -0.02
> >
> > Rd = Rlc + S + Rlc * S
> > Rd = .09 + -0.02 + (.09)(-0.02)
> > Rd = .0682
>
> Obviously this is unhedged return. We got a bit
> off track here though.


I don't see whats wrong with LobsterBoy's calculation, both formulas work out to be the same and can be derived from one another, so I don't understand what you mean by saying it is the unhedged return?

Roflnadal

LobsterBoy Wrote:
-------------------------------------------------------
> Here is perhaps an easier way to do it:
> Rd= Domestic return
> Rlc = Local currency return = Capital Gain + Yield
> Income = .08 +.01 = .09
> S = currency spot appreciation = -0.02
>
> Rd = Rlc + S + Rlc * S
> Rd = .09 + -0.02 + (.09)(-0.02)
> Rd = .0682

Obviously this is unhedged return. We got a bit off track here though.

nannan66

Here is perhaps an easier way to do it:
Rd= Domestic return
Rlc = Local currency return = Capital Gain + Yield Income = .08 +.01 = .09
S = currency spot appreciation = -0.02

Rd = Rlc + S + Rlc * S
Rd = .09 + -0.02 + (.09)(-0.02)
Rd = .0682

Analyze_This

jdane416 Wrote:
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> Wow. Thanks for the clarification. I need to go
> re-read that chapter now.

The bond chapter assumes that returns are equal to Local Return + FC return. Whereas risk management of currencies and the futures section realize currency return is multiplicative.

The reason this assumption takes place is if I buy a 1year coupon TSY, I know all of my cash flows before hand. T1 coupon + T2 coupon and principal. I can hedge via the PV the entire amount rather than any variable amount.

With an equity, I would only hedge T0 value as I am not sure what the value is T + 2, which could leave me overhedged or underhedged come T + 2.



Edited 1 time(s). Last edit at Thursday, June 2, 2011 at 11:11AM by Paraguay.

Roflnadal

jdane416 Wrote:
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> I would love to hear another opinion on this. As
> far I as I know, my formula is the way to compute
> (straight out of CFAI and one of the Mocks).
>
> That being said, I could be completely wrong...

Your 2% is based on forward rates, not spot return.

If you are locking in a 2% forward discount, your formula is correct.

That is not what the question is asking.

The fund's return for the period is 8%. The euro depreciates 2% vs your domestic currency. Div yield for the period is 1%.

I have hedged principal for translation risk, but left returns unhedged as I can't hedge returns ex-ante for currency.

This is straight out of risk management, calculating returns. Your formula is out of the bond chapter and only applicable to fixed assets and assets that you know the discount beforehand.



Edited 1 time(s). Last edit at Thursday, June 2, 2011 at 11:03AM by Paraguay.

former

I would love to hear another opinion on this. As far I as I know, my formula is the way to compute (straight out of CFAI and one of the Mocks).

That being said, I could be completely wrong...

wake2000

Mine is just spot returns. I have hedged 1:1 on principal, but received back only .98:1 based on the gains I made over as the currency depreciated.

cityboy

Interesting... I would solve it using the formula:

Rh = Rl + f

I'm assuming here we locked in a forward discount of 2%, thus:

(.08 + .01) + (-.02) = 7%

Where is your formula coming from?

bodhisattva

jdane416 Wrote:
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> I would take your question one step further and
> ask if the currency movements had been HEDGED,
> what would the return have been?

.08(.98) + .01(.98) = 8.82% assuming principal was fully and perfectly hedged.

Obviously returns would not be hedged.