An investment manager hedges a portfolio of Bunds (German government bonds) with a 6-month forward contract. The current spot rate is €0.75/$, and the 180- day forward rate is €0.72/$. At the end of the 6-month period, the Bunds have risen in value by 3.75% (in euro terms), and the spot rate is now €0.66/$.
a. If the Bunds earn interest at the annual rate of 5%, paid semiannually, what is the investment manager’s total dollar return on the hedged Bunds?
b. What would the return on the Bunds have been without hedging?
c. What was the true cost of the forward contract?