A French investor holds a U.K. security. The investor has estimated the currency exposure in local currency terms to be 1.3. What is the currency exposure in domestic currency terms? A) 1.3. B) 2.3. C) 0.3. Your answer: A was incorrect. The correct answer was B) 2.3. The investor estimated yFC = 1.3. To translate local (or FC) exposure to domestic currency exposure, we use: y = yFC + 1. Hence, the domestic currency exposure is: y = yFC + 1 = 1.3 + 1 = 2.3.
Ok, this is not all that difficult to understand. The currency exposure of a foreign investment essentially consist of two elements: a) the currency exposure of the asset you invest in, and b) your direct currency exposure. Think about it pratically. You are a French investor and you buy stocks in a UK import firm. The stock price of the firm (in GBP) will depend on the performance of the currency - for an importer the value of the firm will inrease in value as the local currency appreciates. An exporter would have the opposite - the value of his firm would increase as the local currency weakens. Now to the second step. Say, your UK importer stock has gained because the local currency has appreciated (in this case by 1,3). This currency appreciation of the GBP versus the USD will increase the USD value for your investment once you translate it back to USD. This will always be by a factor of one, i.e. a 1% appreciation of the local currency vs. the domestic currency will result in a 1% gain. So, the local currency exposure of the security is positive 1,3 (which means that the stock gains in value as the local currency appreciates). Your direct currency exposure is going to be 1 (as explained above), so the total currency exposure is 2,3 - you gain because of the translation effect and because the stock in question rises when the local currency appreciates. I hope this helps!
many thanks kings, I’m too exhausted to dive into the answer right now, but I will tomorrow morning. thanks again