# Currency return

when is the domestic unhedged return: r = Rfc(1+change in S) + change in S (or writen differently r = Rfc + (change in S)(1+Rfc)) and when is it simply: r = Rfc + change in S I keep using the first formula but CFA seems to go for just a simple addition of the Rfc and change in exchange rate. this ignores the change in exchange rate’s effect on the return of the portfolio though? eg CFA 2004 Q9a. I worked out each country’s return using the first formula above and then weighted them to get the final answer but CFA simply did weighted Rf + change in S. Little detail but it’s costing me stupid marks…

I don’t know if it helps, but I always just do: R(unhedged) = (EMV*spot today - BMV*spot at time of investment)/(BMV*spot at time of investment) R(hedged) = R(unhedged) + hedge ratio*(% change in forward rates) I’ve never had a problem going down this route.

mib20 Wrote: ------------------------------------------------------- > R(hedged) = R(unhedged) + hedge ratio*(% change in forward rates) (% change in forward rates) = (F0 - FT) / S0 ?

% change in forward rate…let’s say I have locked in a forward price to sell EUR for USD at \$1.75/EUR and one month later that forward price is now \$1.70/EUR (EUR has depreciated). The % change is simply, 1.70/1.75 -1 = -2.86%. Because I am short euros in this transaction, my forward contract return is actually +2.86%. R(hedged) = R(unhedged) + hedge ratio*2.86%. If you don’t want to switch the signs around, you can always just do: R(hedged) = R(unhedged) - hedge ratio*% change in forward price Just be sure you know which side of the forward contract you are on and you should have no problem.

for unhedged, it is Rdc = (1+Rlc)(1+Rc) so this accounts for the FX impact on the gain or loss of the principal. When you hedge, you essentially locked in two returns, which are Rlc and Rc = Rdc-Rfc. Remember, when you hedge currency, you only do the principal because you don’t know what the end value would be. hope this helps.