“… suppose U.S. investors invest more in a foreign country than the investors of the foreign country invest in the United States. That means the net foreign investment of U.S. investors is positive. Also suppose that U.S. investors axe more risk averse than the foreign country investors. The United States has more hedging demand to sell the foreign currency forward than the foreign country investors have to sell the U.S. dollar forward. The result is that the forward rate (in $/FC) will drop bdow the expected spot rate, and the FCRP on the foreign currency relative to the U.S. dollar will be positive.” Source: Reading 62 Schweser pg 226 (bottom of page) They do not explicitly say that any part of the US currency is NOT hedged - if that is true then FCRP cannot be positive (as they claim). This is because the differences in return between hedged and unhedged equals FCRP. Am I not reading this right.
I think they are over stretching this…true if you accept the equation for FCRP = (E(S1)-F)/S0, then clearly becaue the forward rate has dropped below the expected, due to all those Americans selling the foreign currency forward to hedge their future foreign currency funds. But, FCRP = change in spot rate + interest rate differential. Buying and selling forwards does not change interest rates, and so FCRP cannot become positive or negative because of that.
FCRP is the risk prem is the expected FX appr over int rate differential
i guess schweser is just saying that
- FX will depr as more forwards are available in market
2)the as expected FX is going to be lower than the spot, it is worth hedging.
- if the int rate rate diff is favorable, the likeliness of losing gain to FX depr is high therefore the investor is better off hedging to lock in the +ve FCRP