am confused…dont understand how it’s calculated?.. is it the same as local return+currency return+product of the the two?
i meant from international bond investment perspective…
Simple, from a fundamental standpoint: Beginning investment value in DC at time 0 = Foreign currency amount at time 0 * spot rate at time zero (fast forward to when the return happens) Ending investment value in DC = Foreign currency amount at time T * spot rate at time T (use the prevailing spot rate to convert the foreign currency investment, which has NOT been hedged) The reason it is unhedged is because no futures or offsetting transactions have been made to hedge the foreign exchange risk of the portfolio (economic or transaction). From a “symbol” perspective, unhedged return is: LC return + change in spot rate i.e. You are a US investor with British assets: you achieve a 5% return on the British assets in pounds, but also experience a 2% decline in the value of the GBP (so you get less pounds back into USD at time T) gives you a net “unhedged” return of 3%.
the way i think of it is when you invest in a foreign investment, you want your domestic currency to depreciate. yep, depreciate: that way, when you convert your funds back to your currency, each foreign unit buys you more (depreciated) domestic currency units. i’m usd, i buy a euro bond, i get the return in euros, plus if a euro buys more dollars than before, sweet for me! hedging: hedging locks in your future exchange rate. how does it look it in? well, the country with the HIGHER interest rate is going to depreciate (parity, baby!) so that if usd rates are 5% and EUR rates are 2%, well thats good, cause that means USD will depreciate by 5-3 = 2 hedging locks in this parity rate which is equal to the interest rate differential (of 5 - 3 = 2) if the euro bond earns 3%, i add the other 2% return from hedge and my total return is 5% but… say i have some special insight. perhaps I think the Fed will print more dollars. so i’m thinking, usd will depreciate more, more than is indicated by the parity, more than i can get by buying a hedge so what do i do? i dont hedge. and what’s my return? its return from the bond PLUS my expected depreciation of the USD you hedge, then, if either 1) you don’t have any special insight one way or the other or 2) your expectations are actually for LESS USD depreciation than is indicated by the parity