Question

39. A hedge fund charges an incentive fee of 10% of any investment returns above the T-bill rate, which currently is 3.5% but is subject to a high water mark. In the first year, the fund suffers a loss of 7.0%. What rate of return must it earn in the second year to be eligible for an incentive fee? (Do not round intermediate calculations. Round your answer to 2 decimal places.)

Suppose a U.S. investor wishes to invest in a British firm currently selling for £40 per share. The investor has $12,000 to invest, and the current exchange rate is $2/£.

Suppose now the investor also sells forward £6,000 at a forward exchange rate of $1.90/£.

Calculate the dollar-denominated returns for each scenario. (Round your answers to 2 decimal places. Negative amounts should be indicated by a minus sign.)

	Price per Share (£) Rate of Return (%) at Given Exchange Rate Exchange Rate: $1.80/£ $2.00/£ $2.20/£ £36 % % % £41 % % % £46 % % %

Answer 1

1) Rate of return it must earn in the second year to be eligible for an incentive fee is calculated as below:

Suppose Initial Investment- $100

Given,  incentive fee of 10%,  T-bill rate which currently is 3.5%,  In the first year, the fund suffers a loss of 7.0%.

Amount of Investment= ( Initial Investment*  T-bill rate)= ($100*103.5%)= $103.5

Investment Value= (Initial Investment - Loss Percentage)= ($100- 7%)=$93

It can be seen that nw the company has to pay the investment fees and so the value of Investment should be more than Amount of investment which is $103.50

Calculatiom of the Return ={Amount of Investment-Investment Value) /Investment Value}

= ($103.5-$93)/ $93 = 11.29%

Calculatiom of the New return on investment=(Rate of return/Investment Value*100)= (11.29/93*100) = 12.14%

2)Calculation of  the dollar-denominated returns for each scenario.

British firm currently selling for £40 per share(Starting price)

Price per share (£)	Pound Denominated Return (End of the year price- starting price/ Starting price	Rate of return(%) for the exchange rate of the year
Exchange Rate		$1.80/£(year1)	$2..00/£(year 2)	$2.20/£(year 3)
£36 (case 1)	36-40/40*100)= -10%	-15%	-10%	-1%
£41(case 2)	41-40/40*100) 2.5%	-7.75%	2.5%	12.75%
£46(case 3)	46-40/40*100)=15%	3.5%	15%	26.5%

Calculation of dollor ($) denominated returns for each scenario

Step 1: Convert the value of shares from Pound to Dollar using the Exchange rate given:

British firm currently selling for £40 per share(Starting price)

The current exchange rate is $2/£.

CASE 1

Case1	Starting Price of $(Current price in £*Current Exchange rate in dollar) (A)	(Year-end share price in £* Exchange rate indollarelevant year-end) (B)	Calculationof return=(End of the year price- Starting price)/ Starting price {B-A/A }
Year 1	(£40 per share*$2)= $80	(£36*$1.80)= $64.80	(64.80-80/80*100) = -15%
Year 2	(£40 per share*$2)= $80	£(36*$2..00)=$72	(72-80/80)*100= -10%
Year 3	(£40 per share*$2)= $80	£(36*$2.20)=$79.20	79.20-80/80100= -1%

CASE 2

British firm currently selling for £40 per share(Starting price)

The current exchange rate is $2/£.

Case2	Starting Price of $(Current price in £*Current Exchange rate in dollar) (A)	(Year-end share price in £* Exchange rate indollarelevant year-end) (B)	Calculationof return=(End of the year price- Starting price)/ Starting price {B-A/A }
Year 1	(£40 per share*$2)= $80	(£41*$1.80)= $73.8	(73.8-80/80*100) = -7.75%
Year 2	(£40 per share*$2)= $80	£(41*$2..00)=$82	(82-80/80)*100= 2.5%
Year 3	(£40 per share*$2)= $80	£(41*$2.20)=$90.2	90.2-80/80100= 12.75%

CASE 3

British firm currently selling for £40 per share(Starting price)

The current exchange rate is $2/£.

Case	Starting Price of $(Current price in £*Current Exchange rate in dollar) (A)	(Year-end share price in £* Exchange rate in dolla relevant year-end) (B)	Calculationof return=(End of the year price- Starting price)/ Starting price {B-A/A }
Year 1	(£40 per share*$2)= $80	(£46*$1.80)= $82.8	(82.80-80/80*100) = 3.5%
Year 2	(£40 per share*$2)= $80	£(46*$2..00)=$92	(92-80/80)*100= 15%
Year 3	(£40 per share*$2)= $80	£(46*$2.20)=$101.20	1012-80/80100= 26.5%

Note-Negative sign shows there is a loss and positive sign shows there is a profit

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