You are provided with the following information: Projected bond market returns: US 9% UK 10% Projected Currency returns: Dollar n/a Euro 4% Sterling 6% Yen 6% One year interest rates: US 3% France 4% Japan 1% UK 5% What is the expected return of a US investor investing in the UK market that has hedged the Pound with the US dollar? Possible answers: A: 6% B: 8% C: 10% D: 12%
C
b, hedged return is us int rate + bonds excess return …3% + (10-5) = 8
B
B
superstar123 Wrote: ------------------------------------------------------- > b, hedged return is us int rate + bonds excess > return …3% + (10-5) = 8 B. My reasoning is slightly different: Hedged return = unhedged return + return on hedge Unhedged return = UK Bond Market return = 10% Return on hedge: the return on the hedge should reflect interest rate parity. Expected increase/decrease in Sterling based on interest rate parity: 3% - 5% = -2%. Hedged return 10% - 2% = 8%
B for the win
B. BTW, US bond market is more attractive (9%).
The answer is: B Return = cash + excess bond + excess currency Return = 3% + (10% - 5%) + 0 = 8% Or UK return + forward premium = 10% + (3% - 5%) = 8%
B