Bond Immunization and Exchange Rate Risk: Some Further Considerations
This research project seeks to address two critical problems in the theory of international bond pricing: 1) how can exchange rate risk be formally incorporated into standard bond valuation models?, and 2) how must strategies to â€œimmunizeâ€ bonds against interest rate and inflation risk be modified to also incorporate exchange rate risk? Most of all, this study analyzes the mathematical properties of international bonds (e.g., Eurobonds). A special consideration is given to the two most important characteristics of debt securities â€“ duration and convexity and through them to the various ways to immunize bonds and bond portfolios from real interest, inflation, and exchange rate risks. Fogler (1984) formally addressed the effects of changes in inflation and interest rates on bond prices. Unfortunately, exchange rate risk does not appear to have been formally incorporated into these previous models. Moreover, we correct a mathematical error in Foglerâ€™s analysis.
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