Manage the currency in portfolio
The relationship between return on assets and the exchange rate is critical to international asset prices. The overall impact on the currency depends on the currency structure of exports, imports and financing. You may need to conduct a more thorough analysis of companies engaged in various international transactions. This includes evaluating the company’s operations and financing in each country where they do business.
Using the return on assets, such as inventories and exchange rate fluctuations over a period of time, you can measure the impact of a currency over a specified period.
By understanding the impact on individual companies and assets and the correlations that exchange rate fluctuations have with the return on assets, investors can better assess the currency impact of their portfolio.
Exposure of currency and transactions
Exchange rates affect investors around the world. For example, investors in the automaker Toyota Motor Corp. (TM) have currency risk because the company sells cars in countries outside of Japan. Toyota sells cars in the United States for US dollars, in France for euros, and in the UK for pounds. Upon receiving these foreign currencies, Toyota converts the currencies back into the domestic currency (yen) .1 A change in exchange rates affects the value of the currency that Toyota receives when it is converted back into yen. In turn, this activity affects investors in Toyota.
Investors also have currency risk due to the transaction risk faced by companies involved in international trade. This is the risk of changes in exchange rates after the financial obligations have been repaid. The currency exposure of an asset, such as shares, is the sensitivity of the return on that asset, measured in the investor’s national currency, to exchange rate fluctuations.
The cost of investment is affected by changes in world exchange rates.
Investors, as owners of companies and assets, have currency risk due to exchange rate fluctuations.
The influence of foreign currency on the company’s performance will affect its share prices.
There are three correlations between stock price indicators and exchange rate fluctuations: zero correlation, negative correlation and positive correlation.
Global impact of Forex
Real exchange rate changes can have a significant impact on the economy and international corporations. As real exchange rates rise and fall, revenues, expenses, margins and incentives for companies change.
First, the appreciation of the euro will affect the entire French economy. French goods are becoming more expensive because more foreign currency is needed to buy francs. Thus, net exports outside Europe are likely to decline3. As an exporter from France, Michelin will sell more expensive goods abroad and is likely to experience a decline in total sales. If sales did decline, Michelin’s profitability would hurt, and stock prices could fall.
Alternatively, if the franc depreciates significantly against a basket of currencies, Michelin tires will become competitive. Sales are likely to increase and Michelin’s profitability will improve.3 Moreover, Michelin can lower its sales price in foreign markets without compromising margins, and there will be incentives to produce in France, where production costs are lower.
Investors should note the impact of the US dollar on all assets. Many raw materials, including oil, are valued in dollars. A depreciation of the US dollar tends to increase commodity prices, while an appreciation of the dollar tends to lower commodity prices4. These unique relationships must be taken into account in any currency impact analysis.
Efficiency of stock prices and exchange rate fluctuations
All these forex effects on the company’s performance will certainly have a significant impact on its stock prices. Most investors are affected by these currency changes through equities (although other assets, including fixed income, commodities and alternative assets, are affected by changes in world exchange rates).
There are three general correlations between stock prices and exchange rate fluctuations: zero correlation, negative correlation, and positive correlation.