You are German and own a portfolio of U.S. stocks worth $1 million. The current
ID: 2563637 • Letter: Y
Question
You are German and own a portfolio of U.S. stocks worth $1 million. The current spot and 1-month forward rates are $1.1000/. Interest rates are equal in both countries. You are worried that the results of the coming U.S. elections in 3 days could lead to a strong depreciation of the dollar. Question 1: To hedge FX risk for the principal, you face two choices (1) buy/long forward $1 million, or (2) sell/short forward $1 million. Which is the correct choice? Three days later,your U.S. stock portfolio has gone up to $1.02 million. The spot and forward rates are now $1.1526/e. Question 2: If the portfolio had not been hedged, what is the percentage return (rate of return) in euros over the past 3 days? Question 3: If the portfolio is hedged, what is the profit on the hedge portfolio in euros? What is the percentage return on the hedge portfolio in euros?Explanation / Answer
Answer 1 The investor is bearish on dollar and is expecting a strong depreciation of the dollar. Thus, for the purpose of hedging the investor should Sell short/forward $ 1million. Answer 2 Computation of Return in EURO in case portfolio is not hedged Intial Stock value $ 1 million Stock value after 3 months $ 1.02 million Return $.02 million Spot rate after 3 months 1 EURO $1.15 Therefore, return in EURO 0.017 million % of return Intial portfolio value in EURO .91 million Return in EURO .017 million Rate of return for 3 month 1.87% Rate of return p.a 7.48% Answer 3 Profit on hedged portfolio Intial portfolio value in EURO .91 million Portfolio value after 3 months 1.02 million Hedged part of portfolio 1.00 million Unhedged part of portfolio .02 million Recovery from hedged part IN EURO .91 million Recover from unhedged part in EURO .017 million Total Recovery .927 million Return in EURO .017 million Rate of return for 3 month 1.87% Rate of return p.a 7.48%
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