In CFA topic test: Chung case, the manager is in US, he has AUD bond exposure, the local currency return of the bond is given, and AUD is fully hedged. The spot rate and forward rate of USD/AUD are given.
The CFA answer says that the hedged return is approximately the local currency return of the bond plus the forward discount or premium.
f = (F - S) /S
In the case, the local currency return of the bond, is it in USD or AUD??
Why is the hedged return equal to the sum of local currency return of the bond plus the forward discount or premium? I don’t see that in the CFA curriculum textbook.
This is interest rate parity. Reading 22, page 134 covers it. 3rd paragraph where they begin to talk about the hedged return. The curriculum uses rl to represent the foreign bond return in local currency terms and f to represent the foreign premium/discount.
HR = rl + f
I didn’t care for the question though, as one of the answers was 5.2% (which is what I chose) which finds the forward premium discount using id - if. Even the curriculum says the hedged return roughly equals id + (rl - if). 1.3 + (8.5 - 4.6) = 5.20. But actual exchange rates were given in the question, so I guess we’re expected to use the more accurate calculation of the forward premium/discount. Still, meh kinda weak if you ask me.
Thank you very much! I miss that part.