QUESTION 21

You are British and hold a U.S. Treasury bond with a full price of 100 and duration of 15. Its yield is 6 percent. The dollar cash rate is 2 percent, and the pound cash rate is 3 percent. You expect U.S. yields to move up by 10 basis points over the year. Give a rough estimate of your expected return if you decide to hedge the currency risk. Show that your risk premium is equal to the risk premium of a U.S. investor. Show your work.