Question

Suppose you are a Euro based investor who bought a share of Apple at $300 when the USD/Euro exchange rate was $1.20/Euro. You sell your share when Apple is worth $350 and the exchange rate is $1.10/Euro. You owned your shares for one year. Annual interest rates are 5% on the Euro and 10% on the USD, and you hedge your currency exposure by going short exactly $350 in the Forward market As a Euro based investor, what is your percent return, including the hedge? (eg if your return is 18.20%, enter 18.20)

Answer 1

As per the covered interest rate parity

Forward price = spot price * ( 1 + interest rate on price currency ) / ( 1 + interest rate on base currency )

= 1.20 * 1.10 /1.05 = 1.26 usd / eur

Purchase price in Eur = 300 / 1.20 = 250 eur

Sale price of apple = 350/ 1.1 = 318.18

Profit on hedge tranasction = ( 1.26 - 1.10 ) = 0.16 usd / eur

profit on hedge for 318.18 eur = 0.16 * 318.18 = 50.91

Return for Ero based investor = ( Selling price - purcahse price + profit on hedge ) / purchase price

= ( 318.18 - 250 + 50.91) / 250 = 0.476