2017 Mock Exam AM question 51

Hi, I dont understand why that statement is true. “Wintermantle responds that, in order to fully hedge Japanese yen currency risk, he would need to hedge foreign equity market exposure as well as the currency exposure.” I thought if he does that, he will obtain the risk free rate of his domestic country. Thanks


Agree! Same conflict with me too. As per CFAI curriculum

Earn foreign risk free rate - by hedging the foreign return

Earn domestic risk free rate - by hedging the foregn return and the currency.

But, the answer to this question says different :frowning:


In order to FULLY hedge, you would need to know the ending value of the Japanese assets, because that would be the value that you need to hedge. Because you don’t know that with certainty, you cannot FULLY hedge.

yes that is the answer from the CFAI. Albeit I think is misleading because the intention of the investor is to hedge Rfx and not Rdc and the answer selected as correct suggest you have to hedge both…

so you mean to say that if they wanted it to be hedged in terms of JPY itself - then there’s no need to hedge the currency exposure, BUT since the question is asking to FULLY HEDGE the exposure, they are meaning to hedge it to their domestic value - so that is why its both (foreign asset + currency exposure) - is it? :confused:

No - its just the currency, not the foreign assets. If you hedge 100M JPY based on beginning value and three months later the assets are worth 99M JPY, is there a difference between your hedge value and asset value? Yes - which is what CFAI is getting at here. It’s a bad question, because almost every other way it’s asked that would be a full hedge.