currency appreciation vs depreciation

CFA Level III
#1

Hi, although I read the currency stuff several times now, I am still confused with the effects of curreny appreciation and depreciation. I just can`t remind when I loose money. If currency rates are quoted, I can calculate the effects. However, in some exams questions appeared where my home or the foreign currency depreciated or appreciated and I have problems to remind the effect on my domestic currency reurn (gain or loss). Is there any good rule of thumb, where I can remind me this stuff for tomorrow? Thank you very much in advance Greg

#2

You have an exchange rate quoted as X/Y… All you need to do is look at what’s at the bottom, in this case Y. If X/Y goes up then Y appreciated… If X/Y goes down then Y depreciated…

#3

Isn’t it the opposite? If it costs $1.50 to buy 1 GBP, therefore $1.50/1GBP, and then the exchange rate changes such that now it costs $1.00 to buy 1GBP or $1.00/1GBP (or alternatively, $1.50 / 1.50GBP), effectively the “Y” has gone up, but “Y” has depreciated because it’s cheaper to buy now. Or did I misunderstand your explanation?

#4

In your example, the $ has appreciated and hence the GBP has depreciated. The exchange rate went from a high to a low number which means that whatever was in the denominator has depreciated. i.e. GBP. Which ties up to my illustration…

#5

I always look at it this way: Think of 1.33Euro/ as 1.33 Euro to 1 Dollar. If the spot rate goes to 1.35/ than it takes more Euro to buy one dollar hence the Euro has depreciated against the dollar. If the spot rate goes to 1.3/$ than it now takes less Euro to buy one dollar hence the Euro has appreciated versus the dollar.

#6

Well Explained, mate !

#7

The “price” of a currency (numerator) tells you if you’re gaining or losing on the trade.

  • If your price has gone up, you’re losing if you “bought” (rebuying domestic to close your position is more expensive, more local to buy fixed unit of domestic))

  • If your price has gone down, you’re gaining if you “sold” (rebuying domestic is more cheaper, less local to buy fixed unit of domestic)

Example:

Buy USD/CHK 1.07

Buy 1 CHK

Sell 1.07 USD

USD/CHK moves to 1.09 -> close position

Sell USD/CHK 1.09

Sell 1 CHK

Buy 1.09 USD

Profit/(loss)

1.07/1.09 - 1 = -1.8%

I hope that’s right!

#8

Think of currencies as commodities. (They are.)

If a currency appreciates, its price goes up; if it depreciates, its price goes down.

Suppose that GBP appreciates vis-à-vis EUR. Then it takes more EUR to buy one GBP: EUR/GBP increases; GBP/EUR decreases. EUR has depreciated vis-à-vis GBP.

#9

What I still sometimes find confusing is, say a quote of GBP/USD is 1.5, which in currency terms means # of USD/ 1 GBP; however algebraically the quote of GBP/USD ACTUALLY means: # of GBP/ 1 USD.

The rule though is: Currency Quotes - the 1st currency in the base currency & in algebra the base is the denominator.

Direct Quote= Foreign Currency is the Base Currency (eg EUR/USD for a US investor)

Indirect Quote = Home Currency is the Base Currency (eg GBP/USD for a UK investor)

#10

CFA Institute’s convention is USD/GBP 1.5253 means $1.5253 = £1.0.

#11

This has been CFA Institute’s convention for quite a while now.