Question

Our forward investment manager hedges a portfolio of German Government bonds with a 3-month contract. The current spot rate is Euros .94/USS and the 90-day forward rate is Euros 91/USS. At the end of the 3 month period, the German Govenment bonds have risen in value by 3.00% (in Euro terms) and the spot rate is now Euros 8SUSS. A.) If the Bonds earn interest at the annual rate of 4.00%, paid quarterly, what is the nvestment manager's total USS retun on the hedged German Government bonds? B.) What would the return on the German bonds have been without hedging? Corrent spot 19

Answer 1

Let us assume for simplicity that the investor holds 100 Eros worth of bonds

A) Holding of German bonds in dollar terms today- 100 Euros/0.94= $106.38

Returns in Euros at the end of the 3 month period=1 Euro (interest) +103 Euro (appreciated capital value)=104 Euro

Dollar value of German bonds 3 months later with hedging- 104 Euro/0.91=$114.29

US$ returns per 100 Euros of bonds= $114.29-$106.38=$7.91

B) Holding of German bonds in dollar terms today- 100 Euros/0.94= $106.38

Returns in Euros at the end of the 3 month period=1 Euro (interest) +103 Euro (appreciated capital value)=104 Euro

Dollar value of German bonds 3 months later with hedging- 104 Euro/0.85=$122.35

US$ returns per 100 Euros of bonds= $122.35-$106.38=$15.97