Currency Risk & CFA Rules for calculating: Need someone BRILLIANT!!

CFA Level III Derivatives
#1

Currencies are so frigging’ tricky lol…I think I got it now…but still curious about a few things. Can any of the BRILLIANT guys/gals comment on these points.

  1. This is more a mathematical curosity If a EUR/USD changes by x% why does the USD/EUR also not change by x%. Mathamatically since the number are just reciprocals, should’nt the change % be identical?? I know we need to convert the currencies and then measure the change % again, but why (mathematically speaking) are the percents different??

  2. This has to do with the CFA rules Is the Total Return=domestic return in % + the currency return in % OR is it (1 + r dom)(1+r curr). The text uses both approaches randomly (as far as I can tell)

Comments please…

#2

I will try to answer both:

  1. The demoninator is different (duh cheeky). The larger the denominator the smaller the change. Think about it like this. 1/2 = 50%. 2/1 = 200%. The difference in change is double. You have more invested with a larger base. 3 apples losing two you lost 66%, but 1 apple you get 3 it’s 200% gain. When u minus 1 to get the percentage the discreptence is so much more since 1/1 has a small base.

  2. The most appropriate answer is (1+fx)(1+fc). The first one you posted is approximation since it’s missing (fx)(fc). I just usually multiple all the returns out and divide it by the base price of the asset, that way I don’t have to think.

#3

Hey kys916 :

  1. Great answer: I get it. Thanks.

  2. I know it’s all going to be in domestic ((duh cheeky). Questions is: if the currency return is 2% (say) and the foreign asset return 1%, is the total return a) 3% or b) 1.02 times 1.01 - 1 = 3.02%. I know the EXACT answer is 3.02, but does the CFA use the exact or the approximation?

#4

Siegal’s paradox

#5

I’'d use the multiplication approach: Rdc = (1+Rfx) * (1+Rfc) since that’s the formula in the book…