Currency Hedging - Schweser Volume 1 Exam 1 PM Q 15.3

Iginla2010

why is the answer key here only looking at "excess return" (local return minus local risk free rate) to determine which bond is more favorable?

even though we are using forwards to hedge currency risk, the forwards won't completely eliminate currency return, they will simply lock in the currency return at the difference between the risk-free-rates of their country vs the US risk-free-rate, which is where the firm's investors are located.

why, then, does the answer key not also factor this currency return into which bond is the better investment?

Thanks!

bkballa

I think this is because a perfectly hedged foreign risk free asset yields domestic risk free rate, which will be the same in both bonds (4.8% = Rf US), so the only thing left to evaluate is the excess return above their respective foreign risk free rate.