‘Holding foreign assets can reduce volatility if the local currency is susceptible to easy monetary policy that might lead to a depriciation of the local currency’. Can somebody please help me understand this? What I thought was - an expansionary monetary policy in the foreign country will cause the local currency to depriciate and so it will hurt the return when converted back into the domestic currency. But how does this reduce volatility? Through lower returns? Something is not adding up… please help! Thanks.
local currency = domestic currency if you think dollar might depreciate hold assets in europe
Well, if local currency= domestic currency then it makes sense. But in all the readings (at least in Stalla), the currency of the foreign country has been referred to as the local currency.
They must the referring to the corrleation between currency return and asset return. Given the context, it must be negative corrleation between the currency return and asset return. In the example you sited, expansion in monetary policy cause currency to depreciate, however, if the country is export-dependent, its asset will appreciate. Therefore, reduce the overall volatility of the portfolio. Helps??
Somewhat!
^What are you confused about??
I didn’t catch the local currency thing…frustrating!! local currency is domestic currency What’s the other name for foreign currency?
^FC???
According to Stalla…local currency is foreign currency…and domestic currency is the currency of your home country.
Local Currency is the currency of the country you are investing in, the Base Currency is the currency of the country your based in (or the currency your portfolio is evaluated in). The Local Currency can be the Domestic Currency if I was a US investor investing in Microsoft, however if I was a US Investor investing in Soc Gen the Local Currency would be the Euro and not the US dollar. So Local Currency Does Not Equal Domestic Currency.
bigwilly Wrote: ------------------------------------------------------- > Local Currency is the currency of the country you > are investing in, the Base Currency is the > currency of the country your based in (or the > currency your portfolio is evaluated in). The > Local Currency can be the Domestic Currency if I > was a US investor investing in Microsoft, however > if I was a US Investor investing in Soc Gen the > Local Currency would be the Euro and not the US > dollar. So Local Currency Does Not Equal Domestic > Currency. Exactly my point! So what does the statement mean then?
ws Wrote: ------------------------------------------------------- > ^What are you confused about?? What I don’t understand is if I am a global investor and if the currency of the foreign country I am investing in depriciates, how will that reduce my portfolio volatility?
If it goes to 0 it will reduce your portfolio vol a lot.
AnalyseThis Wrote: ------------------------------------------------------- > ws Wrote: > -------------------------------------------------- > ----- > > ^What are you confused about?? > > > What I don’t understand is if I am a global > investor and if the currency of the foreign > country I am investing in depriciates, how will > that reduce my portfolio volatility? OK, you are a US investor, let’s say you invest in UK equity, and somehow UK currency depreciate, however, due to to corrleation between UK currency and UK equity (let’s assume negative), UK equity went up. Your total US gain/loss=UK currency gain/loss + UK equity gain/loss. If you lose on UK currency and you gain on UK equity===> Your portofolio is not hurt as bad (less volatility)
I’m goign out on a limb here: ‘easy monetary policy that might lead to a depriciation of the local currency’. Ok, Easy Monetary policy means lowering Interest Rates or increase money supply, so currency is going to depreciate most likely, I agree with that point. ‘Holding foreign assets can reduce volatility if the local currency is susceptible to easy monetary’ I believe that countries that participate in Easy Monetary policy has more volatility in their exchange rate b/c it’s not pegged or fixed, and hence controls its own monetary policy so it should be uncorrelated with other exhange rates or other governments policies. If it is uncorrelated to other currencies it should reduce the overall volatility of your portfolio…It doesnt talk about the return which would also depreciate, but you gain the diversification benefit b/c its currency is uncorrelated with other currencies.
Makes some sense now. Thanks guys! 
ws, your explanation assumes that UK currency and equity returns are negatively correlated. If they were postively correlated and UK currency went down, so would UK equity returns, driving the converted US returns down.
^Yes!!!