Domestic currency return

CFA Level III
#1

If the exchange rate changes from 1 D/F to 1.2 D/F, what is the domestic currency return wrt foreign currency?

#2

(1.2 - 1) / 1 = +20% logic: You invested in a forign currency at 1 D/F. Now your converting that investment in foreign currency back to Domestic at 1.2 D/F so you’ve earned 20% from currency appreciation of your foreign investment.

#3

I’m pretty sure that’s wrong…you’re referring to the domestic return in the foreign currency, but he asked what the return on the domestic currency was. It cost $1 to buy a unit of foreign currency, now it costs $1.25 to buy a unit, so the FC got more expensive, and the D currency went down in value.

#4

foreign appreciates so domestic return should fall I guess.

#5

i actually would say that is right… since we do not know the actual return on the investment, the currency appreciated 20%, so when you translate back to domestic you are up 20% plus whatever the asset return was (i know that is not the exact calc but it is close)…

#6

Original 1 unit of foreign currency bought 1 unit of domestic currency; now 1 unit of foreign currency buys you 1.2 units of domestic currency. The foreign currency has strengthened/appreciated, while the domestic currency has weakened/deppreciated. Let’s say the domestic currency is USD and the foreign is EUR…so 1 USD/EUR originally and now you have 1.2 USD/EUR. Foreign currency appreciated 20% Domestic currency depreciated 20%

#7

so answer is -20%, correct?

#8

cfaboston28 Wrote: ------------------------------------------------------- > so answer is -20%, correct? It would be +20%. Think of it as you first convert your investment into foreign currency at a 1 DC/FC rate. Your LMR was 0% and now after a year you want to convert your FC back to DC. The exchange rate now is 1.2 DC/FC so when you convert it back, you actually gained 20% due to currency changes even though your investment had 0% return.

#9

deep, but domestic currency depreciates so doesn’t it mean your investment lose money on currency return. having a brain fart here…

#10

This was the point that is SO confusing. If you get this point, you can’t be fooled on FX conversions. It took me a while of just staring at it before it clicked so don’t be hard on yourself :slight_smile: Your domestic currency depreciated AFTER you had already converted your DC into FC. So when you convert it back, you benefit. If your a US investor and you invest in England, what would give you the best return? If the US dollar DEPRECIATED against the pound then you would be very happy because you were smart enough to convert your US dollars BEFORE the US dollar depreciated. So even if your London stock gets you a return of 0%, its ok because you already made a return from the US dollar’s currency depreciation. Bottom line, if your a DC investor and you invest in any foreign market, your actually betting against your own DC currency since any DEPRECIATION in DC currency vs. the FC currency would be a gain to your portfolio.

#11

awesome mate. Thanks How do you feel overall about your chances for next Saturday?

#12

I’m feeling ok but I think for me it will be all about the AM section. I hate the IPS questions as I can never get em right. I’m ok with the main concepts, but the little detailed sections are my weak area. I honestly think that some portion of passing this exam is due to lady luck because a lot of the people that failed last year would have been definite passers in my book. What about you? Your one of the first to be answering all the ques (and more importantly being right lol) so I’m hoping come exam day I know as much as you!

#13

I am just pretending that I know the stuff :slight_smile: I am also at the same stage like you. I know the main concepts but when they dig deeper than I am dead. AM section is going to be make or break for me too. I haven’t score more than 60 in any of the practice tests. I totally agree that you need luck to pass this exam. There’s no way anybody can know everything given in the books. If they ask you from something which you know, you are golden else totally fked. Hopefully they won’t play their dirty tricks this year and help us let pass the exam.

#14

Hopefully we will both be celebrating our passes and our charters this year along with the rest of the AFers that have sacrificed so much for this exam and designation. I hope this one is worth it, I did engineering undergrad and that was definitely not worth it lol

#15

TLDR: The answer is 20%

Firstly, I advise you always flip FX rates to have your Domestic at the bottom. Also, some key things to remember:

  1. To flip FX rates just use the 1/X function or remember: Foreign/Domestic = 1/(Domestic/Foreign)

  2. You multiply F/D when buying and divide F/D when selling.

Now back to your question which, if you follow my advice, you’d invert and rephrase to: “If the F/D exchange rate changes from 1.0 (1/1) to 0.833 (1/1.2) what is the domestic currency return wrt foreign currency?”

To help illustrate let’s imagine we are a US investor and have USD (domestic/base) but want to buy GBP (foreign/price). We would buy (multiply) $1 by the 1.0 FX rate to get £1. Then later sell (divide) £1 by the 0.833 FX rate. An the end our US investor would get back $1.2 Therefore the domestic return is 20%.