Perpetual Beginner

2008 Asset Class Outlook: Off to a Rocky Start

I don't understand the example of the foreign bond return 5.5% if the dollar depreciates 10% against the foreign currency. I can come up with two scenarios: 1) You exchange dollars for 100 euros (let's say) and buy a foreign bond. At the end of one year you get back 105 euros and then exchange those back for dollars. If the dollar stays even with the euro, you make exactly 5%. If the dollar drop 10% against the euro, you make 15.5%. Conversely, if the dollar appreciates 10%, you loose money. 2) You do the same transaction except you add a hedge in the futures market. The problem is the hedge cost will be the same as the interest rate differential between the dollar and euro bring the 5% return down to the us bond rate. What am I missing here?