2 EOC Questions Fixed Income Ch. 30 currency, expected, difference

DarienHacker

1. For problem #10, you are a British fund with US holdings. UK interest rate is 4.7% and US is 4%. US is expected to appreciate to UK by .4%.

If you do nothing you will lose money because the currency appreciation is not enough to make up for the difference in yield. However it says if you hedge you will stand to make a greater return.

I'm questioning how you make this hedge. The currency is already appreciating in your favor. If it was depreciating this would make sense to me.


2. For problem #20 and #21 you calculate the Hedged and unhedged returns. For hedged you take 10 yr government yield (Risk Premium) minus 1 year RFR. For unhedgeed you take 10 yr government yield (Risk Premium) and then account for currency change.

I'm wondering how come for the hedged return you have to subtract out the RFR. After hedging against currency movement why can't you just use the risk premium?

Thanks.



Edited 1 time(s). Last edit at Friday, April 29, 2011 at 02:36PM by thepinkman.