currency hedged foreign bond return return

ASSet_MANagemen

-The expected local return on the bond is 8.5%.
-The 1 year risk free 1.3% for US.
-The 1 year risk free 4.6% for Australia.
-spot exchange 0.69 USD/AUD
-one year forward 0.67 USD/AUD


What is the expected return on the bond when Australian currency is fully hedged.


The answer 5.2% is wrong.

Reason for it?
thx

dyga

june2009 Wrote:
-------------------------------------------------------
> This was helpful...can anyone explain if below is
> a correct way to think about things? Its that
> last term that always throws me off...is it
> ignored because its usually small?
>
>
> 8.5% - 2.9% + (8.5%*-2.9%) = 5.59% or 5.6%

It's only ignored in international bond convention.

thommo77

This was helpful...can anyone explain if below is a correct way to think about things? Its that last term that always throws me off...is it ignored because its usually small?


8.5% - 2.9% + (8.5%*-2.9%) = 5.59% or 5.6%

Windjam

^ many thanks.



Edited 1 time(s). Last edit at Wednesday, June 1, 2011 at 01:31PM by Oal29.

Darien

This is a legitimate question. And rather straightforward if you ask me.

Rb = Rl + Rc


Where:
Rb = Return on Bond (Domestic Currency)
Rl = Return on Bond (Local Currency)
Rc = Return on Currency Implied by Market (i.e., forward premium/discount)*
= (Forward - Spot ) / Spot

As such:

5.60% = 8.5% + [(0.67-0.69)/0.69)]

5.60% = 8.5% + (-2.9%)


*You cannot use IRP here, because IRP is theory, not actual market numbers. You cannot hedge IRP, but you can hedge using forwards in the markets. That is why the discount is not -3.3%. This is the forward discount IMPLIED by IRP theory.



Edited 1 time(s). Last edit at Wednesday, June 1, 2011 at 01:30PM by forzajuve.

Windjammer

bpdulog Wrote:
-------------------------------------------------------
> Thanks, why are they even going into this formula
> when they have other formulas we have to remember
> for this section that aren't even consistent?
>
> This reading is very convoluted.

I think you mean this curriculum is convoluted. It seems like they had a lot of writers who all wanted to put something in and decided it would be easier to contradict each other than to write together.

I just pray the curriculum is about passing people that know it rather than English and question trickery.

Trickery does not prove who knows things, just who is methodical and not the conservative investor who researches kind.



Edited 2 time(s). Last edit at Wednesday, June 1, 2011 at 01:13PM by Paraguay.

skycfa

Thanks, why are they even going into this formula when they have other formulas we have to remember for this section that aren't even consistent?

This reading is very convoluted.

NO EXCUSES

Analyze_This

132 - 135 V4

Windjam

What page is this on?

NO EXCUSES

Unforseen

pfcfaataf Wrote:
-------------------------------------------------------
> hedged return = (0.67/0.69 x 1.085) - 1
>
> as
>
> 0.67 > 0.69 x 1.013/1.046 (but you hedge at 0.67)

this is incorrect because this solution assumes you hedge the expected return too, but based on the book (as Paraguay said: "Foreign bond chapter says use addition rather than multiplicative. more ambiguity.") the correct solution is:

Posted by: jmac01 (IP Logged)
Date: June 1, 2011 03:31PM

currency return .67/.69-1=-2.9%
local return=8.5%
8.5%-2.9%=5.6%