# Currency Contribution

Given the following info about the growth equity portfolio components, bench mkt info in ( ), Judge whether the contribution of currency movements to the total return is consistent of no active currency management: Country Wgt HK 30% (30%) Wgt Japan 45%(55%) Singapore 25%(15%) Rate of Return in Base Currency HK -4.7% (-4%) Wgt Japan 10.4%(12%) Singapore 15.6%(7.5%) Rate of Return in Local Currency HK -8.7% (-8%) Wgt Japan 2.4%(4%) Singapore 15.6%(7.5%) Currency Contribution HK 4% (4%) Wgt Japan 8%(8%) Singapore 0%(0%) Answer: Option (1) Currency Allocation Effect=Sum(WpCp-WbCb)=0.3*4%+0.45*8%-0.3*4%-0.55*8%=-0.8% compare to total base return 7.1% very small. So no active currency mgt Option (2) Currency Contribution=Portfolio Rate of return in Base - Portfolio Rate of return in Local=7.17%-2.37%=4.8% large compare to 7.1% so active currency mgt presence. Now I am getting completely different answer. Which formula applies here and why?

don’t you have to use standard deviation one to calculate currency exposure and then deduct it from domestic std dev?

singlesong80 Wrote: > > Answer: > Option (1) > Currency Allocation > Effect=Sum(WpCp-WbCb)=0.3*4%+0.45*8%-0.3*4%-0.55*8 > %=-0.8% > compare to total base return 7.1% very small. So > no active currency mgt > > Option (2) > Currency Contribution=Portfolio Rate of return in > Base - Portfolio Rate of return in > Local=7.17%-2.37%=4.8% > large compare to 7.1% so active currency mgt > presence. > > Now I am getting completely different answer. > Which formula applies here and why? singlesong80, Option 1 looks right. Option 2 – You’ve only calculated the “portfolio” currency effect. You need to calc the benchmark currency effect as well, which is 5.6%. You would end up with the -0.8% as option 1.

can you post the source of this question?

it is 2004 Essay The correct answer is option2

There is no contradiction. > Currency Allocation > Effect=Sum(WpCp-WbCb)=0.3*4%+0.45*8%-0.3*4%-0.55*8 > %=-0.8% > compare to total base return 7.1% very small. It should be zero, if no active currency mgnt > Option (2) > Currency Contribution=Portfolio Rate of return in > Base - Portfolio Rate of return in > Local=7.17%-2.37%=4.8% > large compare to 7.1% so active currency mgt > presence. > Wrong to conclude this since you need to compare the performance to benchmark, not on absolute term. Remember, passive currency management means: NO currency risk exposure RELATIVE to the benchmark, and and “Deviating from benchmark currency composition is an ACTIVE currency decision.” thus the following IS active management - NO currency risk exposure on ABSOLUTE level. - NO active hedging (e.g., not using derivatives,…). For this case: same currency contribution on country basis: HK 4% (4%) Wgt Japan 8%(8%) Singapore 0%(0%) However currency contribution is different from benchmark on the portfolio basis: 4.8% in portfolio vs. 5.6% in benchmark as given in the exam. They should be identical also if the manager can claim no active currency mgnt, according to CFAI definition. The cause of this mismatch, thus active management is due to different weighting on each country of the portfolio than benchmark. I leave out the mathematical proof of the last statement as an exercise for the curious readers ;-).

elcfa Wrote: ------------------------------------------------------- > thus the following IS active management > > - NO currency risk exposure on ABSOLUTE level. > - NO active hedging (e.g., not using > derivatives,…). Above-mentioned is “passive” currency management ?

AMC Wrote: ------------------------------------------------------- > elcfa Wrote: > -------------------------------------------------- > ----- > > thus the following IS active management > > > > - NO currency risk exposure on ABSOLUTE level. > > - NO active hedging (e.g., not using > > derivatives,…). > > Above-mentioned is “passive” currency management ? Let me qualify, if one talks about passive currency management in CFAI’s strictest sense, i.e., ‘passive’ currency has to be defined relative to the benchmark being assigned. - If benchmark has currency exposure then for passive currency strategy: portfolio MUST also have currency exposure (identical to benchmark)–> i.e., currency risk exposure on ABSOLUTE level <>0 for passive currency strategy - If portfolio has different weighting on country basis than benchmark (as often the case) then for passive currency strategy: must compensate for that variance --> passive currency strategy must ACTIVELY hedge the variance (via active use of derivatives for example). Not intuitive, is it :-)? All of the above assume that the portfolio mgr is responsible for currency exposure not a separate currency overlay manager. Otherwise, I am referring to pg 216 v6

So the answer is incorrect??? from CFA!!! it is 2004 Essay The correct answer is option2 Obviously, they left out the comparison to bench mark then. With option 1, I would have thought a small deviation such as -0.8% will be negligible. But according to elcfa . it has to be absolutely 0 compare to BM?

singlesong80 Wrote: ------------------------------------------------------- > So the answer is incorrect??? from CFA!!! > > it is 2004 Essay > The correct answer is option2 > > Obviously, they left out the comparison to bench > mark then. > > With option 1, I would have thought a small > deviation such as -0.8% will be negligible. > But according to elcfa . it has to be absolutely 0 > compare to BM? No. I did not say that the answer is wrong. I indicated that I agree with its answer. It says “The contribution of currency movements to the total return of DIAL’s composite does NOT appear to be consistent with DIAL’s statement that it does NOT practice active currency management.” i.e., DIAL does practice active currency management which is what I am saying.

It says further “In asserting that the firm does not engage in active currency management, DIAL may be claiming not that it passively hedges currency exposures away but rather that it accepts and does not modify the currency exposures that naturally result from investing in financial instruments denominated in foreign currencies.” Under this interpretation, the portfolio’s performance is consistent with DIAL’s statement This is consistent with what I am implying: "if you are not interpreting it UNDER CFAI’s STRICTEST sense, i.e., passive currency mgnt means 0 variance from benchmark, but just accept the natural variance coming from ACTIVE decision to deviate from benchmark (from country weighting, but also probably from more currency sensitive stocks than benchmark) --> then you can also claim ‘passive’ currency management.

This so-called ‘passive’ is misleading as I am quoting from CFA p 216 v.6. “A few managers claim that they are passive on currencies, meaning that they do not take view on currency and simply accept the currency exposures. This definition of the term passive currency management can be misleading…” Further on, it says “passive (neutral) decision on currencies is achieved by matching the currency weights in the benchmark. Deviating from the benchmark currency composition is an ACTIVE (my emphasis) currency decision.”