Forward Hedging Calculation Question

CFA Level III Portfolio Management
#1

Struggling with f/x forwards, and this question makes no sense. Anyone can solve this (via analystninja)?

“Tiger Woods is the head of investments for a large U.S institution. He holds a €10 million foreign bond in a U.S investment portfolio. The current spot rate is 1.1000 $/€. Tiger is concerned that the Euro will depreciate against the dollar and enters into a forward contract to hedge his currency exposure, at a forward rate of 1.0800/€. Three months later, the forward rate has fallen to 1.0650, the foreign bond rises to €10.1 million, and the spot rate has fallen to 1.0750 /€.” Determine the hedged domestic return of the foreign bond.

Answer is 0.068%

#2

Yup. Makes no sense.

#3

:confused: damn how can the return be + since he hedged at a lower fx and the return of the bond is 1% :confused:

#4

I am not so sure. The math works out for me.

First I decide whether or not he is buying or selling the forward. He is a US investor with exposure to EUR that he’s looking to hedge so he will sell the forward contract.

Now just take his asset position % gain in USD:

Beginning: 10m EUR x 1.1 = 11m USD

Ending: 10.1m EUR x 1.075 = 10.8575m USD

Calculate the % gain from the above.

Do the same for the currency position assuming that he sold the currency forward, and I end up with .068. Am I missing something?

#5

Future value of Portfolio = 10.1 * 1.075 = 10.8575 M $ (At Spot rate in future time)

Current value of Portfolio = 10 * 1.1 = 11 M $

He would have Sold the currency contract forward at time 0.

So gain on the Forward contract = -10 * (1.065 - 1.08) = 0.15 M$

Net =[10.8575 - 11 + 0.15] / 11 = 0.0006818 = 0.068%

Ans…

#6

Mosstatic - you are missing something - see my calculation above please… You missed the gain/loss on the forward contract itself.