Below both shuold be correct to calculate hedged return. But there is a table and I use it but get the different result…Any thoughts how to choose? Many thanks.
Foreign bond return in local currency terms + forward discount (premium)
Domestic risk-free interest rate + bond’s local risk discount (premium)
The return on a foreign bond (in domestic terms) is composed of its Local Return and the impact of currency movements.If you have hedged against currency movements, you will have by locked-in a forward exchange rate.
To calculate your return in domestic terms, start with the bond’s local return and add the forward premium/discount that you locked-in based on the interest rate differences observed at the time of your investment.Therefore, your hedged return (in domestic terms) can be calculated as:
Hedged return = Local return + forward premium/discount
The above formula can also be stated as:
Hedged return = Local return/yield + YOUR risk-free rate - LOCAL risk-free rate
Note that, as noted to the left, the forward premium/discount is the difference between domestic and foreign interest rates.
If you do NOT hedge against currency movements, your unhedged return can be (roughly) calculated as:
Unhedged return = Local return/yield + Currency Return
Remember, your only guess as to what the currency return will be is based on the difference in current interest rates.BUT, if you are given an EXPECTED currency return, you can re-state the above formula as:
Unhedged return = Local return/yield + Expected appreciation/depreciation of foreign currency vs. your currency