Answer:
a. If the Bonds earn interest at the annual rate of 4.00%, paid quarterly, what is the investment manager's total USS return on the hedged German Government bonds?
Assuming $100 have been invested German Government bonds at Euro 0.94 per dollar investment amount is Euro 94.
Value of German Government bonds ha risen by 3% at the end of 3 months also interest is earned at 4% annually or 1% quarterly.
Value of German Government bonds at end of 3 months
= Euro 94 * (1+0.03+0.01) = Euro 97.76
Hedging using the forward contract rate, value in US Dollar = Euro 97.76 / 0.91 = $107.429
Total USS return on the hedged German Government bonds is $107.42
b. What would the return on the German bonds have been without hedging?
At the end of the 3 month the spot rate is now Euros .85/US$.
Converting to US dollar at spot rate after 3 months
= Euro 97.76 / 0.85 = $115.012
The return on the German bonds without hedging would have been $115.012