Hi guys, I have a question on the unhedged return with forward discount. Kaplan book 3, p79, Example 6
US- based portfolio manager
USD 6 mo LIBOR = 1.2%
GBP 6 mo LIBOR=1.4%
The unhedged return is =2.34%(rolling yield) + 1% (ccy appreciation)
The solution says that since the GBP has a higher interest rate 1.4% vs USD 1.2%
GBP is going to be traded at a forward discount, which leads to (1.4-1.2)/2=0.1%
Hedged return is therefore 2.34-0.1=2.24%
I don’t understand why they are subtracting the forward discount
This is my thought process. Since it’s US based manager, you will eventually turn GBP into USD, so the worry is GBP will depreciate. Thus, to hedge, you short GBP ( say the forward price is 1.3 USD/GBP). Now with the forward discount (1.2 USD/GBP). When you short and the price of GBP drops, you gain. So I think it should 2.34+0.1=2.44% for the hedged return.
What’s wrong in my thought process?Many thanks in advance!!