This question involves B/E spread analsys between two bonds. According to page 138 of vol 4, it is supposed to be the rate differential/longer duration bond = breakeven spread. There’s no mention here of using forwards too.
What am i missing?
This one caught me off guard. I would suggest giving it a try.
In an ordinary breakeven spread analysis, we are given the spreads or nominal returns in domestic currency. But this question gives the local returns.
R(bond x) = Rl + rate diff = 4.55 + (4.55-3.05) = 6.05%
R(bond y) = 7.05% + (4.55-5.65) = 5.90%
Now I can start the process as usual:
(6.05%-5.90%)*(6/12)/7=0.71bps
…
The question asks which bond has a higher return if the yield of bond x increases by 15bps.
Thank you for pointing that out. I never would have gotten it. And now that I look back at CFAI, it is pretty unclear that they are talking about an unhedged interest rate. It is implied, sort of, but it sure would have been nice if they pointed that out.