Question

Mr. James K. Silber, an avid international investor, just sold a share of Nestlé, a Swiss firm, for SF5,080. The share was bought for SF4,600 a year ago. The exchange rate is SF1.60 per U.S. dollar now and was SF1.78 per dollar a year ago. Mr. Silber received SF120 as a cash dividend immediately before the share was sold.

A. Compute the rate of return on this investment in terms of U.S. dollars.

B. In the above problem, suppose that Mr. Silber sold SF4,600, his principal investment amount, forward at the forward exchange rate of SF1.62 per dollar. How would this affect the dollar rate of return on this Swiss stock investment? In hindsight, should Mr. Silber have sold the Swiss franc amount forward or not?  Why or why not?

Answer 1

1. US Dollar Return = Sale Price + Cash Dividend - Purchase price

US Dollar Return = 5080/1.60 + 120/1.60 - 4600/1.78

US Dollar Return = $3250 - $2584.27

US Dollar Return = $665.73

Rate of return = US Dollar Return / Purchase price = 665.73 / 2584.27 = 25.76%

2. Profit from Forward market = Sold Value * (Forward Rate - Spot Rate)

Profit from Forward market = 4600 * (1/62 - 1/60)

Profit from Forward market = -$35.42

Total US Dollar Return = $665.73 - 35.42 = $630.31

Rate of Return = US Dollar Return / Purchase price = 630.31 / 2584.27 = 24.39%

Should Mr. Silber have sold the Swiss franc amount forward or not?

No he shouldn't sold SF in forward market because the actual spot rate is lower than forward rate in SF terms

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