Question 4 a) It is currently 30th April 2024, and a German fund manager holds a...

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Question 4 a) It is currently 30th April 2024, and a German fund manager holds a portfolio of Brazilian bonds currently worth 10 million Brazilian real (BRL) and is worried about a potential depreciation of the BRL over the following 3 months. Data on spot and future exchange rates and the value of the underlying portfolio both at 30th April 2024 and three months later at 31st July is given in Table 3 below. Table 3 Data on spot and future exchange rates and the value of the underlying portfolio Value of portfolio (BRL) Spot EUR:BRL 30 April 2024 31 July 2024 10.0 million 11.2 million 4.6060 4.7872 Required Futures (August 2024 contract) EUR:BRL 4.7750 4.9946 (i) Explain how the fund manager could offset the risk of a BRL depreciation with an appropriate hedging strategy. [2 marks] (ii) Evaluate the effectiveness of any hedging strategy that you suggest by comparing the fully hedged portfolio return with that of the unhedged portfolio. [6 marks] (iii) Calculate the return on the portfolio assuming a 75% hedge ratio. [2 marks] (iv) Discuss how the German investor would determine the hedge ratio necessary to minimise the impact of currency fluctuations on his investment returns. [2 marks] b) Compare the relative merits of employing the following methods of hedging currency risk: (i) Futures versus forwards. [5 marks] (ii) Swaps versus forwards. [4 marks] (iii) Exchange traded futures versus exchange traded options. [4 marks] Question 4 a) It is currently 30th April 2024, and a German fund manager holds a portfolio of Brazilian bonds currently worth 10 million Brazilian real (BRL) and is worried about a potential depreciation of the BRL over the following 3 months. Data on spot and future exchange rates and the value of the underlying portfolio both at 30th April 2024 and three months later at 31st July is given in Table 3 below. Table 3 Data on spot and future exchange rates and the value of the underlying portfolio Value of portfolio (BRL) Spot EUR:BRL 30 April 2024 31 July 2024 10.0 million 11.2 million 4.6060 4.7872 Required Futures (August 2024 contract) EUR:BRL 4.7750 4.9946 (i) Explain how the fund manager could offset the risk of a BRL depreciation with an appropriate hedging strategy. [2 marks] (ii) Evaluate the effectiveness of any hedging strategy that you suggest by comparing the fully hedged portfolio return with that of the unhedged portfolio. [6 marks] (iii) Calculate the return on the portfolio assuming a 75% hedge ratio. [2 marks] (iv) Discuss how the German investor would determine the hedge ratio necessary to minimise the impact of currency fluctuations on his investment returns. [2 marks] b) Compare the relative merits of employing the following methods of hedging currency risk: (i) Futures versus forwards. [5 marks] (ii) Swaps versus forwards. [4 marks] (iii) Exchange traded futures versus exchange traded options. [4 marks]