Can someone explain in detail the answer explanation for practice problem (5). I am missing some points and the answer is not convincing to me.
Yield curve is low in US than in GB… does that mean -> Interest rates high in GB than in US?
What ever newspaper gave…implies that -> $ will depreciate and GBP will appreciate.
Then, how does the explanation given in the answer for practice problem(5) follows? Thanks in advance.
YC (US) < YC (GB) …int rate are high in GB than US…interest rate differentials tell us that US will depreciate & GB will appreciate
so american investor invested in britain= id - if < 0 , pays the interest differential if they hedge US dollar risk…so dont hedge
british investor invested in US = id - if > 0 , receives the interest differential…so hedge
However currency swings are large enough than interest rate differential, it is advisable to hedge currency risk even if you have to pay the interest rate differentials…