So the books tell us : FCRP = delta (FX) - (r_dc - r_fc) Could somebody provide some real life intuition behind it or your understanding of what it is?
Is it just me? I have never seen this acronym in my 5 months of study!!! What acronym is that?
Seriously? FCRP stands for Foreign Currency Risk Premium, and if you don’t know it you better get to work because they are going to test the heck out of it.
Foreign Currency Risk Premium. For example: 1. The Foreign Currency is expected to increase by 5%. 2. Domestic Interest Rate is 4%, Foreign Interest Rate is 3%. Difference is 1%. Therefore, the FCRP is 5% - 1% = 4% In other words, that’s the premium you would expect to receive if you invest in the foreign interest rate. Another way to see this is: Invest in FC risk free sec: 3% Increase in FC: 5% Total Return 8% which is equal to Domestic Rate 4% plus the FCRP of 4% Does that make sense?
well said. not a difficult concept tho so just read it up guys.
Ah! I know Foreign Currency Risk Premium; just never saw the acronym before.
maaagian did a good example, but let me add how I like to look at it. Ask yourself, with the information that is given (i.e. interest rate diffs), what would I EXPECT the currency to do? In the above example, you would expect the foreign currency to appreciate 1% (given the 4% and 3% diffs). But you are told the FC will appreciate 5%. Therefore the premium is 4%. This is an area that simply memorizing formulas may not help if the test gives you the info in a strange manner. Understand the underlying concepts is a big help.
This is also one of my weak points. Literally, the formula is taking the expected changes in forward rate less the interest rate differential between two countries. Essentially, FCRP calculates the foreign exchange premium not explained by inflation. Hope someone can provide a better explanation.
good stuff. thanks a lot. Such a straightforward and easy to understand explanation. Maybe there’s a big market to publish study notes with content like this and titled “Idiot’s guide for CFA level II exam”.
there are a LOT of questions on this at the end of the section in the CFAI books. They helped me out a ton.
Schweser? lxwqh Wrote: ------------------------------------------------------- > good stuff. thanks a lot. > > Such a straightforward and easy to understand > explanation. Maybe there’s a big market to publish > study notes with content like this and titled > “Idiot’s guide for CFA level II exam”.
FCRP is the premuim paid for bearing real risk? is that true?
FCRP is the premuim paid for bearing real ex risk? is that true?
IF there is a premium to be paid for bearing exchange rate risk, that premium is the FCRP. If the difference between the spot rates and expected spot rates is equal to the inflation differential, then there is no FCRP and it is costless to enter into a hedge. If the FCRP = 0, there is no real exchange rate risk and all that remains is inflation uncertainty.