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    The document contains an assignment question from Mzumbe University regarding international finance. It asks the student to: [1] Calculate the expected total annual return of an unhedged bond portfolio across 5 countries. [2] Explain when a currency forward contract should be used to hedge currency exposure. [3] Determine which currency would best proxy hedge bonds from Country B, justifying the response. The student provides calculations for the annual return and explains that forward contracts should be used if the unhedged currency return is less than the forward discount/premium. Country D currency is identified as the best proxy hedge for Country B bonds due to its liquid forward market and higher historical correlation between the two currencies.

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    The document contains an assignment question from Mzumbe University regarding international finance. It asks the student to: [1] Calculate the expected total annual return of an unhedged bond portfolio across 5 countries. [2] Explain when a currency forward contract should be used to hedge currency exposure. [3] Determine which currency would best proxy hedge bonds from Country B, justifying the response. The student provides calculations for the annual return and explains that forward contracts should be used if the unhedged currency return is less than the forward discount/premium. Country D currency is identified as the best proxy hedge for Country B bonds due to its liquid forward market and higher historical correlation between the two currencies.

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    26 views2 pages

    Course Title:: International Finance Management

    Uploaded by

    Eljabri
    The document contains an assignment question from Mzumbe University regarding international finance. It asks the student to: [1] Calculate the expected total annual return of an unhedged bond portfolio across 5 countries. [2] Explain when a currency forward contract should be used to hedge currency exposure. [3] Determine which currency would best proxy hedge bonds from Country B, justifying the response. The student provides calculations for the annual return and explains that forward contracts should be used if the unhedged currency return is less than the forward discount/premium. Country D currency is identified as the best proxy hedge for Country B bonds due to its liquid forward market and higher historical correlation between the two currencies.

    Copyright:

    © All Rights Reserved
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    of 2

    MZUMBE UNIVERSITY

    SCHOOL OF BUSINESS

    BACHELOR OF ACCOUNTING & FINANCE


    IN BUSINESS SECTOR 3 (BAF-PS 3)
    COURSE TITLE: INTERNATIONAL FINANCE

    MANAGEMENT

    NAME: QUEEN K KIMARO


    REGISTRATION NUMBER: 12301025/T.17
    DATE : 27 July 2020
    COURSE CODE: ACC 361
    LECTURER : MR. KIPANGULA
    TASK : INDIVIDUAL ASSIGNMENT

    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.

    i. The unhedged expected annual portfolio return in euros is calculated as follows:

    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:

    Country i = eH,i unhedged expected currency return for country

    Forward premium or discount = cH – ci

    iii. Country D currency would provide the best proxy hedge for Country B bonds for any of the following
    reasons:

     The liquidity of 90-day currency forward contracts for country D is good.


     The relevant currencies − Country B and Country D (hedge) − are historically more highly
    correlated (0.88) and therefore Country D provides a more accurate proxy hedge.

    Where

    W-Proportion weight invested in each asset

    r-Return of each asset

    ehG-Unhedged currency of country G

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