Hi all, Can somebody explain this in plain English please. Many thanks S
If you are a US investor investing in a Japanese asset, it means: (The appreciation you are expecting/seeing with the yen)- interest rate differential (US rate- JPY rate) So if the yen will go up 5% currency wise, but the rate in japan is 10% and 5 % in the states, it says that even though your asset will go up 5%, because the interest is that much higher in JPY, we will see the JPY go down 5% so net will be 0 FCRP
FCRP accounts for the currency risk a domestic investor takes abroad as well as the interest rate you give up by not investing in your home country. in the above example, a US investor buying a japanese asset benefits if the yen appreciates, gives up the US interest rate, but gets the japanese interest rate. that’s why the interest rate differential is always R(dc) - R(fc) and is subtracted from the foreign currency movement.
Thanks ridgefield. good explanation, then what is the logic of writing Rdc-Rfc. Just write +Rfc-Rdc?
yeah that works as well - key is that you’re getting the foreign interest rate but giving up the domestic, so your risk premium should include the difference in domestic and foreign rates (since this is now yield you’re sacrificing to invest in foreign markets).
Interesting way of looking at it. Bookmarked.