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Our investment manager hedges a portfolio of German Government bonds with a 3-month forward contract. The current spot rate is Euros .94/US$ and the 90-day forward rate is Euros .91/US$. At the end of the 3 month period, the German Government bonds have risen in value by 3.00% (in Euro terms) and the spot rate is now Euros .85/US$.
a. If the Bonds earn interest at the annual rate of 4.00%, paid quarterly, what is the investment manager's total USS return on the hedged German Government bonds?
b. What would the return on the German bonds have been without hedging?

Respuesta :

saqib097

Answer:

a. If the Bonds earn interest at the annual rate of 4.00%, paid quarterly, what is the investment manager's total USS return on the hedged German Government bonds?

Assuming $100 have been invested German Government bonds at Euro 0.94 per dollar investment amount is Euro 94.

Value of German Government bonds ha risen by 3% at the end of 3 months also interest is earned at 4% annually or 1% quarterly.

Value of German Government bonds at end of 3 months

= Euro 94 * (1+0.03+0.01) = Euro 97.76

Hedging using the forward contract rate, value in US Dollar = Euro 97.76 / 0.91 = $107.429

Total USS return on the hedged German Government bonds is $107.42

 

b. What would the return on the German bonds have been without hedging?

At the end of the 3 month the spot rate is now Euros .85/US$.

Converting to US dollar at spot rate after 3 months

= Euro 97.76 / 0.85 = $115.012

The return on the German bonds without hedging would have been $115.012

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