April 2006, Q5

Hi,

Unfortunately I don't have a detailed solution for this and I believe that the ASET written for this (which hasn't been available for a number of years) took a different approach to that of the examiners. I think you've probably done quite well in just getting the MWRRs as this was a very difficult question.

In terms of currency returns it's calculated as (Currency rate at start year / currency return at end year) - 1. To convince yourself of this you can think of 1 unit invested at the start of the year that earns currency returns only. E.g. for £1 invested in US dollars we would receive 1.9 dollars at the start of the year. At the end of the year we could convert that 1.9 dollars back into pounds and would receive 1.9/1.75 = 1.08571 so currency returns are 8.571%. The effect on performance then depend on whether we are over/under weight in those currencies. From a currency perspective some outperformance would be generated from being over-exposed to the US as the currency has appreciated but in this case we have held the benchmark weighting.

These currency returns can be applied to the benchmark returns as well, essentially putting everything in £ terms.

Another thing to note:

The Examiners assumed that the indices were total return indices, and hence the index yield was not used in the calculations.

Sorry that I can't be more helpful than this.
Joe