International Excess Return for Bonds

1. Market Selection: bond markets offer the best opportunities for value enhancement
2. Currency Selection: balance between hedging and non-hedging (active currency management)
3. Duration Management
4. Sector Selection
5. Credit analysis – extra gain through credit analysis
6. Markets outside the benchmark

Country Beta/Yield Beta:

Change of foreign interest rate = Country Beta * Change of domestic interest rate +error

Appreciation of foreign currency in the forward rate is called a premium. (traded at forward premium)

Currency differential ~ interest rate differential

Covered interest rate differential (domestic interest rate – hedged foreign rate):

(1+rd)-(1+rf)*F/S

=0 is just interest rate parity

Hedging:

1. Forward Hedge: deliver foreign currency for domestic one
2. Proxy Hedge: deliver 2^nd foreign currency for domestic one
3. Cross Hedge: deliver foreign current for 2^nd foreign currency

Foreign Bond return = local return + expected currency return

Breakeven Analysis: determining the widening in spread between two bonds that will make their total returns the same in a time horizon

Use the one with longer duration.