Determining price and base currency

CFA Level III Portfolio Management
#1

Hi everyone,

Could someone help me out with the following?

(1) How to determine which is the price currency and which is the base currency? For example, if the passage reads “to hedge the long ZAR exposure, the investor sells the ZAR forward (buy the USD)”. How do I figure out what is the price or base currency?

(2) If the passage reads, portfolio’s reporting currency is KRW and the portfolio holds investments denominated in EUR and the current exchange rates are:

  • Spot KRW / EUR = 1,483.99

  • Forward KRW / EUR = 1,499.23

When asked to determine which currency trades at a forward premium or discount, how I do I know whether I should just use the figures above or whether I should use the reciprocal of both and then make the comparison. ie.

  • Spot EUR / KRW = 1 / 1,483.99

  • Forward EUR / KRW = 1 / 1,499.23

Thank you.

#2

To hedge long FC exposure, sell forward FC.

Domestic is usually price currency and foreign is a base currency but is depends wether quotation is direct or indirect. Thus, use logic, always solve from a perspective of the domestic investor.

Buy base on ask, sell base on bid. Buy price on bid, sell price on ask.

#3

KRW is hereby a DC and EUR is a FC.

Sell EUR Forward to hedge a domestic currency return.

Use the first one since EUR (a FC) is in denominator.

(1,499.23 - 1,483.99 ) / 100 = Eur is trading at forward premium 0.1524.

#4

Thanks for the prompt reply. Can you please explain why ou say “Use the first one since EUR (a FC) is in denominator.” What rule or thoughts are you applying to determine that the FC must be in the denominator?

Apologies as I am terrible at FX.

#5

When you say Sell Forward FC, what is the base currency and what is the price currency? My understanding is that the actions to buy or sell are with respect to the base currency so:

  • If the currency is quoted as USD / ZAR, then I would sell Forward ZAR?

  • If the currency is quoted as ZAR / USD, then I would buy Forward USD? This doesn’t make sense to me.

Thanks.

#6

In direct quotations domestic currency is a price currency ( the one in numerator) and foreign currency is a base currency in denominator.

#7

If you’re skilled you can use both ways and quickly recalculate an indirect rate by dividing 1 with direct rate.

If it is difficult for you, stick with the rule described above. DC price, FC base. Read question carefully. Your question says that investor or manager is an US citizen or entity and in another question is Polish. Always solve from domestic perspective.

#8

Sorry KRW is Korean not Polish currency but this fact is not so relevant.

#9

Thank you! You have made things a lot clearer!

#10

Price currency and base currency apply only when you have an exchange rate quote. Here, you have no quote, so there is no price currency and there is no base currency.

You may use either one, so I’d go with what they gave you. (Why add an extra step that takes more time and doesn’t help?)

If the forward number is _ bigger _ than the spot number, then the base currency buys more price currency in the future than it does today: the base currency is appreciating. If the forward number is _ smaller _ than the spot number, then the base currency buys less price currency in the future than it does today: the base currency is depreciating.

When the base currency appreciates, the price currency depreciates; when the base currency depreciates, the price currency appreciates.

Here, you get more KRW for one EUR in the future than you get today, so the EUR is appreciating vis-à-vis the KWR, and the KWR is depreciating vis-à-vis the EUR.

#11

Thanks a lot dear Magician. You continue to cast your magic.

#12

My pleasure, Jahid.

You’re very kind.

#13

If you have no quote, make a quote.

Imo, this is the easiest way to solve for currencies. And don’t let yourself to be confused. Imagine, instead another currency it simply says f.ex. 100 bananas costs $ 101,2569.