Which of the following tasks in the AFIstrategy framework involves putting the formulated strategy into practice through organiz
1 answer:
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<u>Solution and Explanation:</u>
The US investor is Investing in German bond and he is also hedging for the protection against the exchange rate fluctuations
So we have two types of gain, One due to bond and one due to hedging
Part B)
<u>Gain on Bond: </u>
Interest gain = 1% [ 4% per annum ]
Gain due to price change = 3%
Total gain = 3% plus 1% = 4%
These all are in Euro if and the dollar has depreciated so actual gain in USD
Earlier Exchange rate = 0.94
Exchange rate Now = 0.85
Let the investor invested X USD , Convert this into Euro
X USD = X divided by 0.94 EURO
Gain on this is 4% in euro terms, So after 3 months X/0.94 becomes X/0.94 *1.04
Now we will convert this to USD based on current exchange rate so present value
0.9404X
So loss = X minus 0.9404X = 0.05957 = 5.957%
Part A )
Now, we can see the gain by hedging
We have gain of 0.91 minus 0.85 = 0.06 Euro / Dollar
So , we can add this gain to the current spot rate as effective rate will be spot + gain due to forward
Now we will convert this to USD based on current exchange rate so present value = 1.0068X
Profit = 1.0068X minus X = = 0.681%