My two cents on Currency considerations currency, only, foreign, because, investment

bchadwick

Currency Considerations

- Returns are affected by local currency and currency correlations
- Currency risk only slightly modifies the investment risk because
1. is about half of foreign equity risk
2. has built in diversification effects
3. can be hedged
4. can be diversified across many porfolio exposures


Return on foreign asset in USD = (1+Return in LC)(1+%change in foreign Currency) - 1

Return Variance in USD = Return variance in LC + Variance of Exchange rate + 2x S.D of local currency returnxS.D foreign Exchangex correlation between the LC and exchange

S.D of foreign Asset in USD < (S.D of LC + S.D of exchange)
The above statement is true as long the foreign returns and currency are not perfectly correlated

Contribution of Currency Risk = S.D of Returns in USD - S.D of returns in LC

And one important point to note

- Currency risk low correlation with the asset diversifies some of the currency risk away

IAmNeil

onelasttime Wrote:
-------------------------------------------------------
> Return on foreign asset in USD = (1+Return in
> LC)(1+%change in foreign Currency) - 1
>
> Where did you get this from?
>
> I have always seen R (unhedged) = Return on asset
> + s (1+Return on asset) Reading 40
>
> You can also add:
>
> R (Hedged) = Return on asset - hedge ratio x
> return on futures
>
> or
>
> R (Hedged) = Return on asset + return on currency
> x ( 1 - hedge ratio)


R (Hedged) = Return on asset - hedge ratio x
return on futures

or

R (Hedged) = Return on asset + return on currency x ( 1 - hedge ratio)

I can understand the first one, how to get the second one? Are the two "Return on asset" the same?

ohai

Page 351

Return in USD = Return in local + Return of currency + (return in local x return in currency)

In reading 40 the formula
R (unhedged) = Return on asset + s (1+Return on asset) (where s is the return on local currency)
leads to

R (unhedged) = Return on asset + s (1+Return on asset) leads to the same thing

R (unhedged) = return on asset + s + s x Return on asset.

Any others?

mp3bu

LOS 27.b,c,f, CFAI vol3. p351,352, 366

Thanks