Our investment manager hedges a portfolio of German Government bonds with a 3-month forward contract. The current spot rate is Euros .94/US$ and the 90-day forward rate is Euros .91/US$. At the end of the 3 month period, the German Government bonds have risen in value by 3.00% (in Euro terms) and the spot rate is now Euros .85/US$.
a. If the Bonds earn interest at the annual rate of 4.00%, paid quarterly, what is the investment manager's total USS return on the hedged German Government bonds?
b. What would the return on the German bonds have been without hedging?

a. If the Bonds earn interest at the annual rate of 4.00%, paid quarterly, what is the investment manager's total USS return on the hedged German Government bonds?

Assuming $100 have been invested German Government bonds at Euro 0.94 per dollar investment amount is Euro 94.

Value of German Government bonds ha risen by 3% at the end of 3 months also interest is earned at 4% annually or 1% quarterly.

Value of German Government bonds at end of 3 months

= Euro 94 * (1+0.03+0.01) = Euro 97.76

Hedging using the forward contract rate, value in US Dollar = Euro 97.76 / 0.91 = $107.429

Total USS return on the hedged German Government bonds is $107.42

b. What would the return on the German bonds have been without hedging?

At the end of the 3 month the spot rate is now Euros .85/US$.

Converting to US dollar at spot rate after 3 months

= Euro 97.76 / 0.85 = $115.012

The return on the German bonds without hedging would have been $115.012