I’m getting mixed messages throughout the readings Emerging market equity returns often exhibit positive correlations with the value of their currencies True or False: CFAI says true, Schweser is parts says false because as the currencies depreciate exports rise and profits increase. Thoughts?
Definitely true. Developed markets are negatively correlated w/ currency values because exporters benefit from depreciated currency. Emerging markets are negatively correlated w/ currency values because investors pull their money out and the economy is negatively effected when the currency depreciates, etc.
I say true, especially on the downside - falling confidence in economy leads to devaluation of currency and falling equity prices.
Kind of interesting because emerging economies tend to have a huge concentration in natural resources/commodities. You’d think they’d do better with a weak currency. I guess the reasons why the currency is weak speaks more to the economic health of the emerging country rather than how much they can export…
some of the effects are the same… but emerging markets are very, very dependent on confidence. and i’d free-form (non-curriculum) add they have such low labour costs that currency changes probably don’t help as much as they do developed countries. but to put it very simply… emerging markets are very dependent on investor confidence.
In the contagion section schweser speak about EM countries willingly devaluing their currency to remain competitive with other EM countries that started the crisis due to the importance of exports.
McLeod Emerging markets are Positively correlated with their currency. but I think that is what you meant. A good example for the last year was US dollar vs other currencies. When markets went down, dollar increased and the opposite. of course our discussion is broader since it is about the economies not the capital markets but the principle is the same
^Oops, that is what I meant.
I think the effects on the financial account are much stronger in emerging markets than in developed markets. When emerging markets are doing well, more investors want in, need to buy the local currency, and bid up the price. In addition, most emerging markets have done well by exporting to the world, and the demand for their exports drives up the price. If consumers go on a spending binge and buy lots of imports, that will tend to push the currency back down, but it also tends to dampen the performance of the economy because reinvestment suffers. Countries that tried import-substituting industrialization tended to have their currencies fall, but that’s no longer the main approach to economic development. Also, when currencies fell, countries would often try to prop up the currency by selling reserves. If reserves ran out, then the currency would start to fall faster, people would panic, send money out of the country to protect value, and business would be starved for capital. So in reality, the currencies and the economy (or equity market at least) tend to be fairly correlated in emerging markets. This is less true in developed markets because there is usually a better balance between the domestic economy and the export economy such that currency fluctuations have more counterbalancing effects. Now… what does the CFA curriculum say about this? I’m not sure exactly, but probably it says that they’re correlated.
Jscott, you helped me out alot on Swaps last year. Care to do it again? I’m not getting it.