One more currency sensitivity question understand, currency, question, country

kmf229

Another currency sensitivity question from Schweser sample exams, told from the point of view of a Canadian investor
Diversified (the stock) is a metal exporter from Arbutia (made up country)
When the Arbutian currency changes by 10%, the value of the Diversified stock changes by 6%. (I understand the negative correlation: as the currency declines, the stock goes up)
Question:
The sensitivity of the Diversified, measured in Canadian Dollars, to changes in the value of the Arbutian currency is closest to:
A) -.6
B) .4
C) 1.6
I’m totally lost
the answer is B

anshultongia

This one uses the formula R = Rfc +s whisch is just
Return domestic = return Foreign + exchange rate movement
so I would approach this as:
R = -.6 +.1 = +.4 (B)
are you looking for the actual formula, or an explination as to what the formula is implying?

BC_MBA_student

Ok, Diversified is located in arubatia. My “default position” to my own local currency is a sensitivity of 1. However, some firms, such as importers/exporters, will have more or less sensitivity to their own currency.
If the currency moves by 10%, but the firm only moves by 6%, this means i’m not in lock step with the currency. There is a 60% relationship between the sensitivity of firm value to the sensitivity of the local currency.
So 1 (default position) - (.60) = .4
SOmeone please comment on my post, as i also struggle with this area and dont want to be providing false info…

stockjaguar

My questions:
1) I knows this sounds really lame, but who/what is the domestic exposure?
2) Who/what is the the foreign currency exposure
3) Who/what is the “local” currency exposure?

eoin

This one uses the formula R = Rfc +s whisch is just
Return domestic = return Foreign + exchange rate movement
—
foreign return = ?
foreign return = return of foreign stock?
Where did -.6 come from? It’s not in the fact pattern. In order to get to -.6 you must have done something. What did you do, and what were you thinking when you computed -.6?

wizofoz

that’s how I see it.
if you are a US investor holding a security that is based in Euros then if the Euro declines in dollar terms by 10%, but your asset increases by 4% then the total return in terms of dollars would be -.1 + .04 = -.06 or a loss of 6% once you translate back to dollars.
I assume this is correct, somebody correct me if I’m wrong.

bigredhockey55

The company exports – depreciating local currency means stock price increase for an exporter or lets assume the currency appreciates by 10% and the stock falls by 6%.
So you calculate the local exposure (that is, the exposure of local stock price to local currency change) as change stock / change currency. since we have a negative relationship as explained above, that reads -6/10 = -0.6 = local exposure.
Using the formula provided for foreign exposure you get domestic exposure = local exposure +1
=-0.6 + 1 = 0.4
I think that explains where the -0.6 come from. To understand local vs domestic exposure:
the investor lives in Canada here - canada = domestic. The investment is in A. – A. = local. Local exposure is if youre in the country of the investment and consider changes of stock price there vs change in currency. Domestic then refers to the exposure the investor based in another country would have. In this example, the Canadian investor would experience a return that is a mix between the Arbutian currency appreciating vs the CAD and the actual stock return in Arbutian currency (which is negative based on local exposure). If the Arbutian C appreciates it will translate to more CAD for the investor in Canada (his investment is denominated in Arbutian C, so he gains), he can hence offset (some of or all of) the negative stock movement that follows from the local exposure… Hope that makes it a little more clear

AndyNZ

Unfortunately I used different info in my example than what was in the original question you gave.
in the original question you had:
Arbutian currency change (relative to Canadian Investor) of 10%,
Diversified security loss of 6%
so…
if foregn currency appreciated by 10% so with no change in Diversified security you gain 10% to your value from the translation.
But the stock goes down by 6% so even though you gain the 10% in currency terms you’ve lost 6% from the stock return (-.06 +.1 = .04 or 4%)
So that’s the RETURN that you receive as the Canadian investor, now you can find the CURRENCY EXPOSURE which is:
Domestic exposure = return/change in spot
ie. domestic exposure = .04/.1 = .4
I interperet this kind of like duration in the fact that when calcing duration you shock the int rates by a small # of bps but the interpretation is if you had shocked them by 100bps
The .4 is the return you would get if the foreign currency changed by 100%. ie. you would see a 40% return
Again, I am not 100% on this, this is just how I interpreted it as I was reading about it.

noel

Local currency exposure = -.6 (currency up 10%, returns down 6%)
Since we’re assuming a Canadian investor’s viewpoint, we have to add 1 to -.6 which leaves us with .4.