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The Billings Investment Group has increased their proportion of foreign bonds in various portfolios over the past several months. Roger Billings, CEO, believes that not only can the Billings Investment Group reduce risk via lower correlations with domestic bonds, but he also believes that they can enhance returns in the foreign bond market. Billings often relies on “gut” instinct when making bond purchase decisions. He trades frequently to take advantage of temporary market opportunities. Frank Johnson, a trusted colleague and the head trader for Billings relies solely on quantitative models to unearth complex market relationships in the determination of purchase decisions for the portfolio.
The Billings Investment Group has invested in foreign bonds i and j in the recent quarter, and the following data applies:Billings is wondering if they should hedge their position in bond i. If they decide to hedge, they must determine which currency hedging strategy would be the best to use. They are considering several strategies including holding an unhedged position, versus implementing a standard hedge, a cross hedge, or a proxy hedge. Which foreign bond has the greatest expected excess return and what is the excess return?
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