Question
You are overseeing a portfolio of Japanese shares that is held by New Zealand investors. The portfolio is valued at U1 billion. The current exchange
You are overseeing a portfolio of Japanese shares that is held by New Zealand investors. The portfolio is valued at U1 billion. The current exchange rate is U1 = $0.012. The one year Japanese interest rate is 1.1%, while the New Zealand interest rate is 6.5%. Both interest rates are quoted with annual compounding. You are now considering whether you should hedge your portfolio or not. (a) What is the one year forward exchange rate for U? (b) If your portfolio earns a 10% return (in yen) but the yen depreciates to $0.01, what would your portfolio return (in NZ dollars) be if you: i. Did not hedge your exchange rate risk. ii. Hedged your exchange rate risk using forward contracts. (c) Given the large differential in interest rates between New Zealand and Japan, would borrowing money in Japan, investing in New Zealand, and using for- ward contracts to hedge the exchange rate risk be a good strategy? Why or why not?
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