Mr. James K. Silber, an avid international investor, sold a share of Rhone-Poulenc only, a French firm, for FF42. The share was bought for FF42 year ago. The exchange rate is FF6.15 per U.S. dollar and was FF6.65 per dollar a year ago. Mr. Silber acquired FF4 like a cash dividend instantly before the share was sold. How would this concern on the dollar rate of return on this French stock investment? Should Mr. Silber have sold the French franc amount forward or not, in hindsight? Why or why not?
While FF42 is sold forward, the investor's profit is decreased:
Profit($) = 42 (1/6.15 - 1/5.80)
= 42 ($.1626 - $.1724)
= -$.41
Therefore, the total return of investment is:
R($) = [(9.31-6.32-.41)/6.32]x100 = 40.82%.
Because of hedging, the return became lower. By hindsight, Mr. Silber must not have entered into the forward contract.