Qasim Omer works as a consultant on currency management at Linda Asset Management headquartered in Canada. His role requires Qasim to provide consultation to portfolio and fund managers within Linda Asset Management as well as external clients (including high net-worth individuals and institutional investors).

Samantha Jones who is an equity portfolio manager at Linda approached Qasim in September seeking advice to manage a £5,000,000 position in U.K. equity security. Samantha has just purchased this U.K. equity security for her portfolio. Her expectations were that the U.K. equity security will earn a relatively higher return than similar Canadian equity securities, however, she feared a weak £ relative to C$ over the period. Qasim advised that Samantha hedge 100% of the £ exposure to managing this risk.

Samantha immediately executed the hedge by entering into enough December futures contracts to sell ₤5,000,000 for Canadian dollars at a futures exchange rate of C$1.75/₤. At the time, the spot exchange rate was C$1.80/£.

After one month, the value of the U.K. equity is £5,200,000 with a spot exchange rate of C$1.70/£ and future priced at C$1.65/£. Samantha is interested to know the payoff and asks Qasim to calculate the net profit or loss on the hedged U.K. stock position. Qasim made the following statement to Samantha before initiating his analysis:

“The return on a hedged stock will differ from the stock return achieved in foreign currency for the following reasons: foreign exchange transaction costs, stock price volatility, and the interest rate differential.”

Required:

Calculations of the net profit or loss from Samantha’s hedge of the U.K. equity security.

Answer rating: 100% (QA)

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