A British fi xed-income fund has substantial holdings in US dollar-denominated bonds.

Th e fund’s portfolio manager is considering whether to leave the fund’s exposure to the US dollar unhedged or to hedge it using a UK pound–US dollar forward contract. Assume that the short-term interest rates are 4.7 percent in the United Kingdom and 4 percent in the United States. Th e fund manager expects the US dollar to appreciate against the pound by 0.4 percent. Assume IRP holds. Explain which alternative has the higher expected return based on the short-term interest rates and the manager’s expectations about exchange rates.