WTF: 2015 Mock Exam CFAI Question #40

“Short interest rates are currently 2.50% in the United Kingdom and 3.25% in Germany and that Delta’s currency strategists forecast that the euro will depreciate by 0.35%.”

Based on Delta’s expectations regarding currencies, and assuming that interest rate parity holds, should Delta most likely recommend using forward contracts to hedge the portfolio’s British pound exposure?

A. No, because the euro is expected to depreciate by more than 0.35%

B. Yes

C. No, because the euro is expected to appreciate by more than 0.35%

OK so A is correct: the Euro is expected to depreciate by 2.50-3.25=0.75. So I chose answer A because if you think the Euro is only going to depreciate .35% and not .75% then don’t hedge. But the answer is B apparently because “yeah, A is right, but nevertheless, hedge anyway.”

Why does CFA say hedge anyway? Would you short a forward against the Euro to hedge?

Um . . . they’re hedging GBP exposure, not EUR exposure.

They’re not saying “A is right, but hedge anyway.” They’re saying “A is wrong (and so is C); choose B because it’s right.”

B! Lock in the gain.