An Italian investor owns a portfolio of South Korean stocks worth 1.25 billion won. The current spot and one-month forward exchange rates are 1,250 won/ (one won 0.0008 euro). Interest rates are equal in both countries. You are worried that some rumor about the bankruptcy of a major local bank could lead to a strong depreciation of the won. You have observed that Korean stocks tend to react negatively to a depreciation of the local currency (won). A broker tells you that a regression of Korean stock returns (measured in won) on the /won percentage exchange rate movements has a slope of 0.50. In other words, Korean stocks tend to go down by 0.5% when the won depreciates by 1%.

a. Discuss what your currency hedge ratio should be.

b. A month later, your Korean stock portfolio has gone down to 1.1875 billion won and the spot and forward exchange rates are now 0.00072 /won.

Analyze the return on your hedged portfolio.