To hedge or not to hedge?

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iamMichael

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Question in a topic test states:
EURO is the domestic currency and Interest Rate Parity applies here!
Germany interest rate is 3.5%
UK is 2.75%
EUro is expected to depreciate by .35%
The question ask if you should hedge or not?
The answer is YES! Does anyone know why?
I picked one of the wrong answers!
 
Your domestic currency is the Euro, so you would benefit from a bigger depreciation against the foreign currency, that’s why you should hedge.
 
is it because interest rate parity predits a depreciation of .75 which is more than .35?? currency is my worst topic though :/
 
almostdone1822 wrote:
is it because interest rate parity predits a depreciation of .75 which is more than .35?? currency is my worst topic though :/
Click to expand...
Yep
 
As you are holding the assets labelled in GBP, locking a depreciation rate of .75% of the EUR (an appreciation of the GBP of .75%) has a positive effect on the EUR value of your GBP holdings. If you do not hedge they will only appreciate in EUR by .35%. so you hedge to take advantage of that
 
can someone explain this?
how this .75 calculated. m confuse with formula. f (discount/premium)= i(domestic - i(foreign)
 
The additive formula for Fp/b = Ip - Ib, which means the base currency is trading at a forward premium.
 
I still dont understand it! I am crazy maybe?
I have a $1 in my portfolio in EURO. If I know the EURO is going to drop by 75%. I should heldge so that I don’t lose money? Is that right?
 
iamMichael wrote:
I still dont understand it! I am crazy maybe?
I have a $1 in my portfolio in EURO. If I know the EURO is going to drop by 75%. I should heldge so that I don’t lose money? Is that right?
Click to expand...
I hope not.
Your currency is the Euro, that’s the one you want to maximize.
Now if you are long in GBP asset + currency, you want the GBP returns on both to be very high. To do that, the Euro must go down in front of the GBP, because currency values are all relative. So you want the GBP to appreciate vs the EUR, or the EUR to depreciate vs the GBP, to get the most EUR when it’s finally time to bring back that money in GBP home. So locking in a 0.75% in a IRP is more profitable than the expected 0.35%.
 
OOOKKKKKK! I got it.
How do we know the asset is in GBP?
Thats probably why I am confused..it just says the domestic currecny is EURO? I didnt pick that up!
Berg’s committee then asks Delta to make a recommendation about whether the portfolio
should be hedged back to the euro, its domestic currency…
 
If the domestic currency is the EUR… then the other one must be the foreign currency
 
Where can I find the multiple choice mock from 2015? I only see the essay section on the website? Thanks!
 
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