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Course Title:: International Finance Management
Course Title:: International Finance Management
SCHOOL OF BUSINESS
MANAGEMENT
QUESTION. Requirements
i. Calculate the expected total annual return (euro-based) of the current bond portfolio if Irene
decides to leave the currency risk unhedged. Show your calculations.
ii. Explain, with respect to currency exposure and forward rates, the circumstance in which Irene
should use a currency forward contract to hedge the current bond portfolio’s exposure to a given
currency.
iii. Determine which one of the currencies being considered by Irene would be the best proxy hedge
for Country B bonds. Justify your response with two reasons.
WG × (rG + eH, G) + WA × (rA + eH,A) + WB × (rB + eH,B) + WC × (rC + eH,C) + WD × (rD + eH,D)
= 0.25 × (2% + 1.5%) + 0.4 × (1% + 2% – 4%) + 0.1 × (4% + 1% + 2%) + 0.1 × (3% + 1% – 2%) + 0.15 × (2.6%
+ 2.4% – 3%)
= 0.875% – 0.4% + 0.7% + 0.2% + 0.3%
= 1.675%
= 1.68%
ii. If Irene expects the unhedged percentage return from exposure to a currency to be less than the
forward discount or premium; forward contract should be used to hedge exposure toward that
currency. The situation can also be expressed as:
eH, i < cH – ci
Where:
iii. Country D currency would provide the best proxy hedge for Country B bonds for any of the following
reasons:
Where