What is Forward Rate in terms of hedging

CFA Level III
#1

Reading 26, Example 9

Please correct me if i’m wrong, I’m trying to get a better understanding of this interst rate / currency hedging stuff.

So if you have a Euro denominated bond, and want to hedge it back to the US in 1 year. Lets say you hedge it with a forward contract.

That forward contract rate / currency exchange you locked in represents the future exchange rate factoring in the US risk-free return rate? correct?

When you execute that future in 1 year, you have hedged the Euro interest rate and currency rate risk?

So in the end your return components are the US interest rate + USD currency rate?

I’m just having trouble understanding all the moving parts of why we take certain steps and what it means.

thanks,

#2

The forward rate is based on today’s USD risk-free rate and today’s EUR risk-free rate.

You’ve hedged against any _ relative _ EUR/USD interest rate risk.

You get tue USD risk-free rate plus the EUR risk premium (above the EUR risk-free rate).