Quiz time! You invest in a fund denominated in euros. The fund’s return for the period is 8%. The euro depreciates 2% vs your domestic currency. Div yield for the period is 1%. What is the portfolio’s rate of return in your base currency for the period? Giddy up.
6.82%
that’s what i got too when i stuck the formula for these random #'s. good man, goodman. SS17.
Should be .08 + .01 + -.02(1+.08 + .01) = 6.82%
correct sir. i was reviewing SS17 and that was just one of those little formulas that i totally forgot was even out there. figured i’d just post it up. it’s simple. just need to refresh the ol’ memory.
could you please give reference to the page… i can’t find that formula in SS17 in schweser books
i think the question must differentiate between return from capital appreciation and income
YUP its chapter 47. TOTAL RETURN IN BASE CURRENCY= capital gain component + yield component + currency component
Just a different dimension to the wording of the above question. What is to ascertain that the dividend yield of 1% is not already included in the fund’s return for the period stated as 8%!
Question - on some questions, we include the -.2*8% as the third leg and other times we do not. What is the "rule’ on this?
Paraguay, why did you put the “1” in the last part of your formula? Doesnt that effectively add a 100% gain to the currency effect in addition to the +.08 and +.01 gains? I’ve seen formulas where it would make the last term in the formula contain -.02(.08 + .01)…when do we need to add the “1” and when do we keep it out?
So the currency movement should be applied to the principal (that’s why he puts the “1”) AND to the actual returns in local currency.
I would take your question one step further and ask if the currency movements had been HEDGED, what would the return have been?
jdane416 Wrote: ------------------------------------------------------- > I would take your question one step further and > ask if the currency movements had been HEDGED, > what would the return have been? .08(.98) + .01(.98) = 8.82% assuming principal was fully and perfectly hedged. Obviously returns would not be hedged.
Interesting… I would solve it using the formula: Rh = Rl + f I’m assuming here we locked in a forward discount of 2%, thus: (.08 + .01) + (-.02) = 7% Where is your formula coming from?
Mine is just spot returns. I have hedged 1:1 on principal, but received back only .98:1 based on the gains I made over as the currency depreciated.
I would love to hear another opinion on this. As far I as I know, my formula is the way to compute (straight out of CFAI and one of the Mocks). That being said, I could be completely wrong…
jdane416 Wrote: ------------------------------------------------------- > I would love to hear another opinion on this. As > far I as I know, my formula is the way to compute > (straight out of CFAI and one of the Mocks). > > That being said, I could be completely wrong… Your 2% is based on forward rates, not spot return. If you are locking in a 2% forward discount, your formula is correct. That is not what the question is asking. The fund’s return for the period is 8%. The euro depreciates 2% vs your domestic currency. Div yield for the period is 1%. I have hedged principal for translation risk, but left returns unhedged as I can’t hedge returns ex-ante for currency. This is straight out of risk management, calculating returns. Your formula is out of the bond chapter and only applicable to fixed assets and assets that you know the discount beforehand.
Wow. Thanks for the clarification. I need to go re-read that chapter now.
jdane416 Wrote: ------------------------------------------------------- > Wow. Thanks for the clarification. I need to go > re-read that chapter now. The bond chapter assumes that returns are equal to Local Return + FC return. Whereas risk management of currencies and the futures section realize currency return is multiplicative. The reason this assumption takes place is if I buy a 1year coupon TSY, I know all of my cash flows before hand. T1 coupon + T2 coupon and principal. I can hedge via the PV the entire amount rather than any variable amount. With an equity, I would only hedge T0 value as I am not sure what the value is T + 2, which could leave me overhedged or underhedged come T + 2.