Given a US investor, he invest in S&P and get domestic currency return of 5%, he also invest in UK and get UK pound return of 7%, spot rate=1.5 USD/Pound, US 1 year interest rate is 3% and UK 1 year interest rate is 4%, he short a one year pound Forward contract, with forward price 1.3 USD/Pound. if fully hedged, what’s the USD return for his UK market. I think it is 7% (UK pound return), is it correct?
He had a negative 7.4 return. Example: Take 500 and invest in UK market at 500 / 1.3 = 333 Pounds Grows to 333 x 1.07 = 356 pounds in one year. Uses forward to convert into : 356 x 1.3 = $463 Loses 7.4%
if it is 80% hedged, how to calculate? under which circustance, we have partial hedge instead of fully hedged? If it is fully hedged, I think it should be 7%+(1.3-1.5)/1.5=-6.3% instead of -7.4%
linping85 Wrote: ------------------------------------------------------- > if it is 80% hedged, how to calculate? under which > circustance, we have partial hedge instead of > fully hedged? > > If it is fully hedged, I think it should be > 7%+(1.3-1.5)/1.5=-6.3% instead of -7.4% I have never seen the total return being calculated like that. Currency return is always taken out after you have got the total return in US$
Local Market Return = 7% Futures return = (1.3-1.5)/1.5 = -13.33% (1.07)(.8667) = .9274 - 1 = -7.26% return 80% hedge: Currency return (assuming futures = spot at t1) = (1.3-1.5)/1.5 = -13.33% Domestic return = .07-.1333(1.07) = -.0726 (same as 100% hedge since exchange rates behaved the same for spot and futures) 80% hedge return = -.0726-.8(-.1333) = .034