Question 4 a) It is currently 30th April 2024, and a German fund manager holds a portfolio of Brazilian bonds currently worth 10 million Brazilian real (BRL) and is worried about a potential depreciation of the BRL over the following 3 months. Data on spot and future exchange rates and the value of the underlying portfolio both at 30th April 2024 and three months later at 31st July is given in Table 3 below. Table 3 Data on spot and future exchange rates and the value of the underlying portfolio Required 30 April 2024 31 July 2024 Value of portfolio (BRL) 10.0 million 11.2 million Spot EUR:BRL Futures (August 2024 4.6060 4.7872 contract) EUR:BRL 4.7750 4.9946 (i) Explain how the fund manager could offset the risk of a BRL depreciation with an appropriate hedging strategy. (ii) Evaluate the effectiveness of any hedging strategy that you suggest by comparing the fully hedged portfolio return with that of the unhedged portfolio. | (iii) Calculate the return on the portfolio assuming a 75% hedge ratio. (iv) Discuss how the German investor would determine the hedge ratio necessary to minimise the impact of currency fluctuations on his investment returns.

Essentials Of Investments
11th Edition
ISBN:9781260013924
Author:Bodie, Zvi, Kane, Alex, MARCUS, Alan J.
Publisher:Bodie, Zvi, Kane, Alex, MARCUS, Alan J.
Chapter1: Investments: Background And Issues
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Question 4
a) It is currently 30th April 2024, and a German fund manager holds a portfolio of Brazilian bonds currently
worth 10 million Brazilian real (BRL) and is worried about a potential depreciation of the BRL over the
following 3 months. Data on spot and future exchange rates and the value of the underlying portfolio
both at 30th April 2024 and three months later at 31st July is given in Table 3 below.
Table 3
Data on spot and future exchange rates and
the value of the underlying portfolio
Required
30 April 2024
31 July 2024
Value of
portfolio (BRL)
10.0 million
11.2 million
Spot
EUR:BRL
Futures (August 2024
4.6060
4.7872
contract) EUR:BRL
4.7750
4.9946
(i) Explain how the fund manager could offset the risk of a BRL depreciation with an appropriate
hedging strategy.
(ii) Evaluate the effectiveness of any hedging strategy that you suggest by comparing the fully
hedged portfolio return with that of the unhedged portfolio. |
(iii) Calculate the return on the portfolio assuming a 75% hedge ratio.
(iv) Discuss how the German investor would determine the hedge ratio necessary to minimise the
impact of currency fluctuations on his investment returns.
Transcribed Image Text:Question 4 a) It is currently 30th April 2024, and a German fund manager holds a portfolio of Brazilian bonds currently worth 10 million Brazilian real (BRL) and is worried about a potential depreciation of the BRL over the following 3 months. Data on spot and future exchange rates and the value of the underlying portfolio both at 30th April 2024 and three months later at 31st July is given in Table 3 below. Table 3 Data on spot and future exchange rates and the value of the underlying portfolio Required 30 April 2024 31 July 2024 Value of portfolio (BRL) 10.0 million 11.2 million Spot EUR:BRL Futures (August 2024 4.6060 4.7872 contract) EUR:BRL 4.7750 4.9946 (i) Explain how the fund manager could offset the risk of a BRL depreciation with an appropriate hedging strategy. (ii) Evaluate the effectiveness of any hedging strategy that you suggest by comparing the fully hedged portfolio return with that of the unhedged portfolio. | (iii) Calculate the return on the portfolio assuming a 75% hedge ratio. (iv) Discuss how the German investor would determine the hedge ratio necessary to minimise the impact of currency fluctuations on his investment returns.
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