I don’t understand what are stated in the solution. Current yield curve is much lower in US means I/R is much lower in US and GBP shall depreciate against USD, so it shall be ATTRACTIVE (favorable) for US investor to hedge currency risk on British assets. Am I wrong ? Anyone can comment ?
According to IRS, yes you are correct. This is addressed in the second paragraph of the answer. The first paragraph refers to paying the difference in the interest rates. I don’t know why this is included. Maybe they’re thinking about hedging with a currency swap rather than a forward…?
It’s because when you hedge the currency risk (risk of FC decreasing), you sell the FC currency forward and therefore “pay” the FC interest rate while earning the DC interest rate. This concept is stated on the reading 40 CFAI page 316 on the bottom under “costs”.
Going back to the example on the book, if USD rate is 1% and GBP rate is 4% and you want to hedge the risk of GBP decreasing, you need to sell GBP fwd. So you are borrowing in GBP at the GBP rate of 4% and earning the USD rate at 1%. I hope it’s clear. This is not a transaction cost but a cost born by hedgers.
mik82 Wrote: ------------------------------------------------------- > Going back to the example on the book, if USD rate is 1% and GBP rate is 4% and you want > to hedge the risk of GBP decreasing, you need to sell GBP fwd. So you are borrowing in GBP > at the GBP rate of 4% and earning the USD rate at 1%. I hope it’s clear. > This is not a transaction cost but a cost born by hedgers. Then, if interest differential is accounted form, shall US investor to hedge currency risk on British assets ?