Hedged Return

CFA Level III Fixed Income
#1

If a question gives you the risk free yields AND the spot and the fwd currency rates, which do you use to calculate the impact of hedging?

i.e. Fixed Income CFA Topic Test - Chung, Q6

  • solution used the spot/fwd

  • I used the risk free yields

#2

Use the quotes, that’s how you hedge.

#3

As I understand it, if all they give you are Rf rates, then use the differential. If they give you actual S & F currency prices, then I think the fully hedged return will be simply be [(F/S)-1]

The problem I had with that question was that the answer required you to add the asset return (8.5%) and the currency return (-3.16) to determine the return with the bonds fully hedged. So their answer was 5.34%

It seemed to me that the curriculum method was multiplicative (i.e., Rd = (1+Rfc)(1+Rfx) - 1) so my calculation was Rd = (1.085)(.96840)-1, which gave me 5.071%, and I got the question wrong. I’m not certain now when to use an additive return and when to use a multiplicative return.

#4

Use multiplicative when in doubt. The additive is only useful when compounding is not an issue (percentage change).

#5

Ah yes I stumbled upon this q as well its from CFAI past paper. Seems the textbook says hedged return = local return + forward premium / - forward discount ? I think thats the formula. Yea nt sure wts the difference between two forumlas too, multipicative and additive

#6

pretty sure all the examples I’ve seen have been additive? where have you seen multiplication in the solution?

#7

Additive is an approximation.

If it’s an EOC, do the multiplicative, if it’s not in the choices, do the additions. I’d say go for the multiplicative in AM, although I’m sure both should be fine as they’re very close.