Break Even Analysis computing, advantage, question, example, currency

Chuckrox8

Hi all,

I'm sure I came across a question in one of the Schweser exams that relied on currency appreciation/depreciation IN ADDITION to the yield advantage/disadvantage for the highest duration bond when computing the price change. However, this isn't mentioned in the CFA text.

For example (1 year horizon)

Australia: Bond A Yield: 5% Duration: 5
Brazil: Bond B Yield: 4% Duration 3

Australia has a yield advantage of 1% hence price depreciation of 1%, divide by -5 = 0.2%

All fine so far, but would this change if the Exchange rates moved during the investment horizon?

Thanks.

Analyze_This

> so conclusion: does not hurt to take forward
> premium into account.

However, if the question states clearly IGNORING THE effect of exchange rate (which is what I expect the exam will state as mentioned earlier), you MUST NOT use the forward premium.

Analti_Calte

What about in Q9-D in Exam 3 Vol 1...they adjust the breakeven spread for the forward discount/premium...i had this same problem about the fact that we are meant to ignore exchange rates and yet in this Q they adjust for them?
Schweser's response was that it's because they're international bonds but that's often been the case and we stil ignore exchange rates as that's what breakeven does?

wake2000

grgkir001 Wrote:
-------------------------------------------------------
> What about in Q9-D in Exam 3 Vol 1...they adjust
> the breakeven spread for the forward
> discount/premium...i had this same problem about
> the fact that we are meant to ignore exchange
> rates and yet in this Q they adjust for them?
> Schweser's response was that it's because they're
> international bonds but that's often been the case
> and we stil ignore exchange rates as that's what
> breakeven does?

There are two different things.

1. One ignores the CHANGE (i.e., volatility of exchange rate) which is what I wrote to answer a_thinking_ape's question earlier.

2. Given that, there are still two different methods of calculating breakeven.
One is to take into account forward premium (i.e., hedged return), the other is ignoring the forward premium.

Schweser (I believe) consistently uses the first alternative (i.e., incorporate forward premium).

CFAI (I believe) allows both. In the book "FIXED INCOME ANALYSIS" issued by CFAI (a lot this book is level II and level III reading), there are explicit examples showing the breakeven with and without forward premium.

so conclusion: does not hurt to take forward premium into account.