CFA CFA Level 3 CFAI practice questions: Portfolio Trading-Perf Eval-GIPS – Chung

CFAI practice questions: Portfolio Trading-Perf Eval-GIPS – Chung

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      6-6 hedged return=Return in foreign currency+ forward discount=8.5-3.16=5.34
      The given answer used spot and forward price to calculate the forward discount(-3.16%). However, the item set also provided foreign and domestic interest rate. The forward discount(-3.3%) calculated by IRP is different with previous method.
      Hedged return can also be calculated using domestic risk-free interest rate(1.3%) plus local risk premium (8.5%-4.6%), it will give an answer with 5.2%.
      Which method should be used here? And why?
      Thank you in advance.

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      Hey @Ying, would you clarify where this question came from in the CFAI syllabus? It’d help the community to help you out as not all of us has the reference books anymore (like good ol’ me).

      Normally it’s best to paste the whole question here, or as an image, which would help the discussion

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      Here is the question.

      The expected (local currency) return on the bonds is 8.50%, and the 1-year risk-free yields are 1.3% in the United States and 4.6% in Australia. The spot exchange rate is USD0.6900/AUD1 and the one-year forward rate is USD0.6682/AUD1.

      Given the exchange rate and interest rate data provided, if the Australian currency risk is fully hedged, the bond’s expected return will be closest to:

      5.20%.
      5.34%.
      3.90%.

      Thank you!

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      Thanks Alta12, but that did’t answer my question. The answer given is 5.34%, not 5.2 %. Please see my first message. My question is between those two approach, why we should use RLC+f discount. and f discount calculated with exchange rates is different from IRP.

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      There must be something else mentioned in the question. This question is not in mock A, B or C. Where are you getting it from?

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      @ying @Sophie

      Hedged:
      RDC = RLC + (id -if)
      = 8.5% + (1.3%-4.6%)
      = 5.2% (A)

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      Hi @Sophie, thank you for your respond. I was being silly. What does 6-6 mean really? lol. This is a question from practice tests offered by CFAI, it’s under the last session, Portfolio Trading-Perf Eval-GIPS – Chung. Do you still be able to see the test?

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      @vincentt which mock is this?

    • Avatar of vincenttvincentt
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        • CFA Level 3
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        @alta12 not in any mocks, go to candidate resources and click on the “Portfolio trading, GIPS, etc etc”, you’ll be taken to this sample test.

      • Avatar of vincenttvincentt
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          The text:
          On the basis of earlier discussions with the pension fund’s managers, Chung was prepared to recommend a model portfolio with a duration of 5.0 years, measured against U.S. interest rates. More recently, Chung was told that the pension fund owns $100 million worth of Australian bonds that must be held in the $500 million portfolio for the next 12 months. These bonds have a duration of 3.2 years and Chung estimates that Australia’s country beta is 0.80. The expected (local currency) return on the bonds is 8.50%, and the 1-year risk-free yields are 1.3% in the United States and 4.6% in Australia. The spot exchange rate is USD0.6900/AUD1 and the one-year forward rate is USD0.6682/AUD1.


          @ying
          not that I would know how to answer this question correctly on my first attempt but after looking at the solution it’s nothing complicated at all.

          Basically, it’s just P/L on Foreign Bond + P/L on Currency Exchange.

          Return on the bond is expected to be:
          8.5%

          As for currency exchange P/L:
          Spot exchange rate $0.69/AUD
          Forward rate = $0.6682/AUD

          The question asked for fully hedged, which means you will get the forward rate that you sold.

          So let’s assume you did not hedge it but the forward rate will be the exact rate in 12 months time (This is exactly the same as selling a forward).

          1. Buy AUD 100m @ $0.69/AUD (using $69m)
          2. and 12 months later
          3. Sell AUD 100m @ $0.6682/AUD (you’ll get $66.82m)

          66.82 / 69m – 1 = -3.159%

          A loss of 3.159%, which is the same as the solution (F – S) / S = (0.6682 – 0.69) / 0.69 = – 3.16%

          So to sum it up the total return would be 8.5% + (-3.16) = 5.34%

          Thanks for raising this question.

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