# Hedged Return vs Unhedged Return: Schweser VolII 18.2

Return on Bergn Petroleu bond in Norwegian Nkr 7% Risk free rate in Norway 4.8% Expected change in the NKr relative to the U.S. dollar -0.4% Risk free rate in U.S. 2.5% Should the Bergen Petroleu bond be hedged against currency risk and what is the hedged return? Answer: Hedged: 7%+(cd-cf)=7%+2.5%-4.8% Unhedged: 7-0.4=6.6 my question is the undeged, I would think it should be Rlc+S+Rlc*S=7%-0.4%+7%*(-0.4%) because the exchange rate change not only apply to principle but also return!

singlesong80 Wrote: ------------------------------------------------------- > Return on Bergn Petroleu bond in Norwegian Nkr 7% > Risk free rate in Norway 4.8% > Expected change in the NKr relative to the U.S. > dollar -0.4% > Risk free rate in U.S. 2.5% > > Should the Bergen Petroleu bond be hedged against > currency risk and what is the hedged return? > > Answer: > Hedged: 7%+(cd-cf)=7%+2.5%-4.8% > Unhedged: 7-0.4=6.6 > > my question is the undeged, I would think it > should be > Rlc+S+Rlc*S=7%-0.4%+7%*(-0.4%) because the > exchange rate change not only apply to principle > but also return! CFAI defines the unhedged return as “approximately equal to foreign bond return in local currency, plus the currency return”; hedged return as "foreign bond return in local currency, plus the forward currency premium/discount; So I think the Schweser answer is ok.

If interest rates in Aust are 10% and interest rates in Canada are 5% then you expect the Aust dollar to depreciate by 5% rel to Canadian dollar. If you could hedge a position to ensure a better result than a 5% depreciation, then you would do it. So looking at this question, the IR differential is 4.8%-2.5% = 2.3%, therfore the futures market pricing would assume a 2.3% depreciation of the Nkr. If you expect the change in NKR rel to dollar to be -0.4%, then ofcourse you would stay unhedged. And the answer is right. Thats my recollection of it, hope i havent led you down the garden path!

Am I getting this correct from Happyking02? Rlc+S+Rlc*S=7%-0.4%+7%*(-0.4%) is an accurate unhedged return? but 7%-0.4% is an acceptable approximation? I understand the whole hedged and unhedged comparison logic. Only question is what is the exact unhedged return here.