We have: domestic currency exposure = local (foreign) currency exposure + 1 and ICAPM: E® = Rf + (beta x MRP) + (currency sensitivity x FCRP) My question is, which currency exposure (domestic or local) should we use for the currency sensitivity in the ICAPM?
domestic currency exposure!
doesn’t it depend on the FCRP??
I think it is local currency exposure ( i.e. the relation of the stock returns to local currency appreication or depreciation ). This has to do with importer losing when LC depreciates and exporters gain when LC depreciates )
Think of an American investor investing in a Japanese stock… and if the stock`s exposure with yen is given then in order to calculate the $ returns convert yen exposure to dollar exposure ( formula :: gamma(LC) +1 )
varun, you’re exactly right. that’s how schweser presents it so if i see a US investor I always look for DOLLAR exposure and if i see YEN exposure i add one to get domsetic exposure. my question though is, if that is the case, how come in the multiple choice Q where we are given a little chart of betas, exposures, and sensitivities, it seems like we are choosing the local currency to use in the ICAPM formula. you can see this in cfai volume 6 page 515 #13. is yEURO and ySFR the DOLLAR exposure to those currencies? and if so, how would you represent the euro & SFR exposures to thsoe currencies?