2015 PM Mock #23 Fixed Income

CFA Level III
#1

Can someone please provide more guidance as to why the answer to #23 is sell euros and by dollars? The answer states, “the Forward rates for both the dollar and the euor fully reflect the interest rate differentials as expected by interest rate parity. As such, forwards reflect that the dollar is expected to appreciate relative to the pound and the euro to depreciate relative to pound. Kingsbridge’s view, however, is that the dollar will appreciate more than the forward implies and the euro will depreciate more than the forward implies. The result in actively managing the portfolio is that Kingsbridge should hedge the the euro bonds into the dollar.”

This is an area I am weak at with respect to fixed income, if anyone can explain this with the numbers used in the exhibit I would greatly appreciate it. Thank you.

#2

I do not get this too.

#3

I don’t have it in front of me, but since the investor expects the dollar to appreciate more than implied by the forward rate, then that means the principal of the investment (let’s say EUR 100,000) would get him _ less _ dollars by that time, so he locks in a certain amount of dollars on the forward rate, expecting that the Euro will depreciate more than that, and buy less dollars for him.

Remember that any foreign investment is the local return and the foreign currency return. You hedge when the foreign currency return is expected to depreciate as much, or more than implied by the forward rate, and the opposite is true.

#4

Thanks Mr Smart, I understand that but the part after that- wheather selling dollars or euros that part I do not comprehand.

#5

I do not comprehend your question either, which part?

#6

BUMP

Struggling on this question. I expect Dollars to appreciate more than the forward rate, so I will buy dollars forward? Won’t this lock in a lower price

I expect euros to depreciate less than the forward rate, so I will sell euros forward? Won’t I lock in a worse price

#7

Depends on your domestic currency.

#8

My domestic currency is pounds. I expect the dollar to appreciate more than the forward rate against the pound, so why would I buy dollars forward? Won’t this lock in a lower price?

#9

Don’t you mean sell dollars forward?

And yes, it will, you shouldn’t hedge in that case.

#10

Bump, same as 2017 pm mock 35

My domestic currency is pounds. I expect the dollar to appreciate more than the forward rate against the pound, so why would I buy dollars forward? Won’t this lock in a lower price?

#11

  1. You currency have dollar bonds. This is a good thing. So you wouldn’t hedge, as you think you will get more.

  2. You get alpha from currency management, this means you are taking positions not only to hedge, but making money.

Right now I can lock in .6137 BP per 1 dollar. I EXPECT to be able to sell a dollar for even more than the future, that is .6173. So I’m BUYING dollars at .6137, and will be able to SELL them in the spot for .6173. Another way to look at it, the expected future rate is GREATER than the Forecast, so I want to buy something low and sell high.

The BP is DEPRECIATING to the dollar, and is DEPRECIATING even more expected then what the future gives us.

#12

I see, i und the USD apreciate more than expected point, i thought the answer says it means also buying USD through the forward market, which will make less gains then not heding basically

so what the ans means is selling EUR through forward but buying dollar (not thru forward)?

#13

You are buying dollars in the forward, by selling British pound. Because when you go to swap them (Get forward, then open market sell), you will swap dollars FOR EVEN MORE British bounds.

Hedging would be SELLING the Dollar. We are currently EXPOSED to the dollar via our bonds. We are INCREASING our exposure to the dollar to get currency alpha.