Currency hedging are covered in two readings in different terminologies (one in SS10 and one in SS15).
Under SS10:
Unhedged return: LMR + LCR
Hedged return: LMR + (Rd - Rf) => LMR + (F-S0)/S0
Under SS15:
Unhedged return: Rd,u
Hedged return: Rd,u + %change in future price => Rd,u + (F0-Ft)/S0
Is my understanding correct? Please someone validate this and correct me if I’m wrong…Thanks!
SS10 is looking at total returns of foreign bonds translated back to a domestic investor.
Unhedged return would be
(1+RL)(1+Cr) -1. I think your answer would suffice.
Hedged return:
HR = RL + Forward Premium/discount ==> Forward Premium/discount = (F0-S0)/S0 or ~ (iD - iF) which is the interest differential between the domestic and foreign interest rates.
Rearrange the equation and you get…
HR = iD + (Rl - iF) or…
Domestic Risk-Free rate + local bond’s risk premium. It allows us to compare hedged yields from any foreign market.
Study session15
HR = Rd,u + %chng in future
HR = Rd,u - (Ft-F0)/S0. => We’re long the unhedged, and SHORT the future.
Good answer, this confused me at one point as well.