Foreign Currency Summary - Formula, etc. difficult, expected, currency, tackling, remember

DoubleDip

I always had a difficult time tackling FX issues. So I have summarized all the formulas relating to foreign currency issues:

1) Economics:
Expected Risk Premium using ICAPM for a foreign market. No FX issues addressed here but remember for an integrated market ERP = Corr i,m x std dev i x sharpe ratio m

2) Case for International Diversification:
Two formula for a foreign asset and local asset:
first old risk and return formula for marks a and b
expected return = wt a x r a + wt b x r b
std dev = ( wt a^2 x var a + wt b^2 x var b + 2 x w a x w b x cov a,b )^1/2
std dev a x std dev b x corr a,b = cov a,b

International market correlations:
return in domestic currency = return local + currency change in % + return local x currency change in %

var of returns in USD = var of return in local + var of currency + 2 x std dev local x std dev of curr x corr of local and currency

Contrib of currency risk = std dev in USD - Std dev in local currency

3) Fixed Income:
If IRP holds
return on foreign bond = domestic return + (foreign bond premium)


4) Currnecy Risk Mgmt:
Min variance hedge
Optimal hedge ratio = translation + economic

translation = 1

economic = ( cov of return in local curr with currency change )/ variance of local returns

currency delta is same as delta in options.

ohai

This is good.