Stone fields a call from Edisto Palma, an MPA portfolio manager in the Madrid office. Palma is frustrated with the negative interest rate environment present in the European Union (EU) debt markets resulting from the European Central Bank’s quantitative easing programs. He tells Stone he is considering buying securities outside of the EU market to pick up additional yield. Stone informs Palma that he is sympathetic with the situation but that there are implications to buying securities outside his EU benchmark, whether they are from developed or emerging markets. Stone outlines three suggestions for Palma. First, he should evaluate whether the spread advantage is negated by the cost of a currency hedge. Second, he should avoid local currency investments in countries where the exchange rate is pegged. Third, he should ensure that the timing of the credit cycles across markets coincides.
Question
Which of the suggestions Stone outlines for Palma in selecting the proposed investments is most likely correct? The one regarding:
- local currency investment is most likely correct.
- spread advantage is most likely correct.
- the credit cycle is most likely correct.
B is the correct answer and I get it. But through all three levels CFA has emphasised on how pegging currency leads to issues , why isn’t A the correct answer?