Additional info: there was a 6 month hedge at initiation.
Isn’t the roll yield fixed at the contract initiation [ ( F – S0) and not (F – S1)] ? – so even if the hedge would not be rolled forward, the roll yield would still exist, right ?
The “more/less negative” is about overall return ? If not, how is it a part of roll yield ?
I referred the notes dictated in class and in all 3 cases ( spot increase/decrease/same), the roll yield was constant. And overall return was different.
The core is not very clear regarding how to classify this profit/loss from change in spot rate at T. While it states that roll yield = (F – S0)/S0, it also mentions that if the spot rate at time T is different from S0 then that change (be it positive or negative) will increase/decrease the roll yield.
Note that roll yield calculation assumes that spot rate remains unchanged i.e., at T spot rate is still S0. But, if S at T is indeed different from S0 then that affects roll yield. It’s advisable to not worry about the naming of this component of return and treat it as is given in the core.
Following is the relevant write-up in core:
The magnitude of roll yield is given by |(FP/B – SP/B)/SP/B| where “||” indicates absolute value. The sign depends on whether the investor needs to buy or to sell the base currency forward in order to maintain the hedge. A positive roll yield results from buying the base currency at a forward discount or selling it at a forward premium (the intuition here is that it is profitable to “buy low and sell high”). Otherwise, the roll yield is negative (i.e., a positive cost). Examining the case of negative roll yield, assume that to implement the hedge requires buying the base currency in the P/B quote, and that the base currency is trading at a forward premium (as shown in Exhibit 7). By using a long position in a forward contract to implement this hedge, it means paying the forward price of A. All else equal, as time passes the price of the forward contract will “roll down the curve” toward Price B as the forward contract’s settlement date approaches. (Note that in reality the curve is not always linear.) At the settlement date of the forward contract, it is necessary to roll the hedging position forward to extend the currency hedge. This rolling forward will involve selling the base currency at the then-current spot exchange rate to settle the forward contract, and then going long another far-dated forward contract (i.e., an FX swap transaction). Note that the portfolio manager originally bought the base currency at Price A and then subsequently sold it at a lower Price B—and that buying high and selling low will be a cost to the portfolio. Or put differently, all else equal, the roll yield would be negative in this case. Note that the “all else equal” caveat refers to the fact that the all-in price of the forward contract consists of the spot rate and forward points, and both are likely to change over the life of the forward contract. It is possible that at the settlement date the spot rate would have moved higher than A, in which case the roll yield would be positive. But the larger the gap between A and B at contract initiation, the less likely this is to occur.
Volume 3, Pg 382