Consider a U.S. portfolio manager who holds a portfolio of French stocks currently worth :10 million. In

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Question:

Consider a U.S. portfolio manager who holds a portfolio of French stocks currently worth :10 million. In order to hedge against a potential depreciation of the euro, the portfolio manager proposes to sell December futures contracts on the euro that cur- rently trade at $1/€ and expire in two months. The spot exchange rate is currently $1.1/€. A month later, the value of the French portfolio is €10,050,000 and the spot exchange rate is $1.05/€, while the futures exchange rate is $0.95/€.

a. Evaluate the effectiveness of the hedge by comparing the fully hedged portfolio return with the unhedged portfolio return.

b. Calculate the return on the portfolio, assuming a 35 percent hedge ratio.