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CFAI practice questions: Portfolio Trading-Perf Eval-GIPS - Chung
6-6 hedged return=Return in foreign currency+ forward discount=8.5-3.16=5.34
The given answer used spot and forward price to calculate the forward discount(-3.16%). However, the item set also provided foreign and domestic interest rate. The forward discount(-3.3%) calculated by IRP is different with previous method.
Hedged return can also be calculated using domestic risk-free interest rate(1.3%) plus local risk premium (8.5%-4.6%), it will give an answer with 5.2%.
Which method should be used here? And why?
Thank you in advance.
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Answers
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The expected (local currency) return on the bonds is 8.50%, and the 1-year risk-free yields are 1.3% in the United States and 4.6% in Australia. The spot exchange rate is USD0.6900/AUD1 and the one-year forward rate is USD0.6682/AUD1.
Given the exchange rate and interest rate data provided, if the Australian currency risk is fully hedged, the bond's expected return will be closest to:
5.20%.
5.34%.
3.90%.
Thank you!
Hedged:
RDC = RLC + (id -if)
= 8.5% + (1.3%-4.6%)
= 5.2% (A)