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My question is: foreign bond return should be negative correlated with foreign currency movement relative to domestic currency. So, there is no need for currency hedging for bond portfolio. Why the above statement says currency risk should be hedged? Let’s say a Canadian investor hold US bond. As US interest rate increases, US bond price falls. US bond portfolio experiences loss. But USD appreciates relative CAD because of carry trade. That is a positive impact for US bond portfolio. So, currency exposures should provide diversification benefit to fixed-income portfolios. Why the above statement is the opposite?
Not sure what you mean “But USD appreciates relative to cad because of carry trade.” Why would your carry trade attempt cause the USD to appreciate?
The USD could appreciate to the CAD, in which case, your hedge may likely make less money than non-hedged return, due to the cost… But what if USD depreciates to the CAD, then your hedge would be better than the non-hedged version?
Carry trade means: if US interest rate increases, investors tend to buy USD to benefit from rising yield, which can cause USD appreciates.
No, that’s not what carry trade means.
OK. Ignore the name. But I think the logic is correct.
when interest rates in USD increase, yes people will want to invest there vs the CAD. However , covered interest rate parity says USD’s forward will depreciate. I dont think definitve the direction of the currency. Many other factors.
But I still do not understand why correlation between foreign-currency returns and foreign-currency asset returns tends to be greater for fixed-income portfolios. As foreign bond price increases, foreign currency also appreciate? Why?
Covered IRP _ does not _ make predictions about future exchange rates, despite what the bulk of finance types tell you.
Covered IRP has one job and one job only: to prevent arbitrage.
The author goes on to say that many studies don’t support this “intuitive” sense.
I don’t understand this “intuition”. (And, frankly, I’m getting pretty tired of people in finance talking about intuition. Forget about intuition and strive for understanding.)
I’d ignore that passage and concentrate on what’s important.