 # Currency hedging - recap and a ques

unhedged return = return on bond + currency appreciation + (return on bond * currency appreciation ) only market return hedged = foreign risk free rate both currency and market hedged = domestic Rf my brain is completely fried, so maybe this is a rather simple ques:- what is the return when you hedge only the currency risk ? say u r US investor Bond A (yen) = 6% Rf rate (yen) = 2% Rf rate (\$) = 4.8% whats the return on bond if currency is hedged

approx it is 6 + (4.8-2)

thats the unhedged return. return on bond + diff between the Rf rates

no that is hedged return. your future rate will be IRP which is approx 4.8-2% appreciation of yean. Unhedged return is no one knows what the spot will be

Disregard.

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have you tried out schweser vol 1 exam 1, PM i can’t understand ques 15.3 and 15.4 , pg 55

hedged return is return on bond + return on currency future unhedged return is return on bond + return on currency based on spot price

for 15.3 - because currency risk is hedged away you want the better “risky” return. you take the nominal payout of the bond and reduce it by the risk free rate. for 15.4 - i think the answer should be D. For the Tatehiki bond we know that an unhedged return of a forieng asset is: asset return + currency return +A*C = 8.8% (despite schweser saying its 8%, i think they’re wrong). schweser screwed up their wording on this one; they meant to say fully hedge the knauff bond…for the bond that uses contracts to hedge currency risk, we know that the bond should return the domestic risk free rate (i.e. the U.S rate) to minic the contracts plus the ‘risky’ return…so in thi scase 4.8% + 3% = 7.8%

strikershank Wrote: ------------------------------------------------------- > schweser screwed up their wording on this one; > they meant to say fully hedge the knauff > bond…for the bond that uses contracts to hedge > currency risk, we know that the bond should return > the domestic risk free rate (i.e. the U.S rate) > to minic the contracts plus the ‘risky’ > return…so in thi scase 4.8% + 3% = 7.8% thanks striker, the rest of it i understood. but this part i’m not getting. Fully hedged would mean only the domestic Rf . where does the plus risky return come from ?

bips Wrote: ------------------------------------------------------- > strikershank Wrote: > -------------------------------------------------- > ----- > > > schweser screwed up their wording on this one; > > they meant to say fully hedge the knauff > > bond…for the bond that uses contracts to > hedge > > currency risk, we know that the bond should > return > > the domestic risk free rate (i.e. the U.S rate) > > > to minic the contracts plus the ‘risky’ > > return…so in thi scase 4.8% + 3% = 7.8% > > > thanks striker, the rest of it i understood. but > this part i’m not getting. > Fully hedged would mean only the domestic Rf . > where does the plus risky return come from ? If you would invest in JPY market and then hedged market return AND currency you would earn US rfr

strikershank Wrote: ------------------------------------------------------- > for 15.3 - because currency risk is hedged away > you want the better “risky” return. you take the > nominal payout of the bond and reduce it by the > risk free rate. > > for 15.4 - i think the answer should be D. For the > Tatehiki bond we know that an unhedged return of a > forieng asset is: asset return + currency return > +A*C = 8.8% (despite schweser saying its 8%, i > think they’re wrong). > > schweser screwed up their wording on this one; > they meant to say fully hedge the knauff > bond…for the bond that uses contracts to hedge > currency risk, we know that the bond should return > the domestic risk free rate (i.e. the U.S rate) > to minic the contracts plus the ‘risky’ > return…so in thi scase 4.8% + 3% = 7.8% it’s 8.8% if you hedge the japanese yen based on current IRP, if you leave it unhedged the return should be 8% because the JPY is only expected to appreciate 2%, so 6+2=8%

comp_sci_kid Wrote: ------------------------------------------------------- > > If you would invest in JPY market and then hedged > market return AND currency you would earn US rfr I know that. but i can’t understand why add risky return to domestic Rf. i’m being too daft but i can’t seem to wrap my head around this

bips Wrote: ------------------------------------------------------- > comp_sci_kid Wrote: > -------------------------------------------------- > ----- > > > > If you would invest in JPY market and then > hedged > > market return AND currency you would earn US > rfr > > > I know that. but i can’t understand why add risky > return to domestic Rf. i’m being too daft but i > can’t seem to wrap my head around this bond is clearly risk as it earns spread over jpy rfr. You are not hedging this spread.

tank you are forgettting the third part of the formula . the multiplicative term. what u r doing is a rough approx

theTank - i don’t understand: “it’s 8.8% if you hedge the japanese yen based on current IRP, if you leave it unhedged the return should be 8% because the JPY is only expected to appreciate 2%, so 6+2=8%” if its unhedged don’t we get the bond return, plus the currency return for the initial value of the bond AND then we get the bond return*currentcy return for the increase in our initial value? how come in your example of an unhedged bond it only returns 8%?

it would be 8.12% then by your calc it would be 6% + 2% + (6% x 2%) = 8.12%, same as 1.06 x 1.02, they approximate this to 8% say you have 100JPY, return is 6 JPY, currecy up 2%, so that’s 2JPY on your original 100 and 2% of your return of 6 so 0.12 JPY add it together and its 8.12JPY

ahhh - fack - i fat fingered my calculator. ok, so i had the theory right, i just filled in the wrong circle. Better now then exam day!

Thank you, i think i got it. thanks

so, final answer is 8.8% right?