THe equation is y=y(LC) + 1. What ranges can this value go to? A negative correlated exposure to currency means this value is less than 1? What will a positive correlated currency exposure mean?
Well if the asset has a negative exposure to exchange rate movement then y(LC) = -1. So let’s say everytime the Swiss fracn appreciate this one Swiss company/stock depreciate. Then essentially y=0. So this would essentially be a wash for say an US investor investing in this company? Did I get this right guys?
Correct… a y(LC) = -1 would mean, perfect negative local currency exposure for LC. Thus this would act as a implicit hedge tool for any Foreign companies investing…
Yeah, that’s right ! If you converted USD to buy EUR denominated bonds, then y(LC) is the correlation between the bond price changes and local currency (EUR) value changes . But y(LC)+1 shows how your USD (domestic currency) return changes due to the changes in EUR value. Thus the range can be from 0 (EUR growth equal to bond price decline) up to 2 (investment wins twice - on EUR up and bond price up)
What is y? How would they ask a question on this? So if a currency has positive currency correlation that means that as interest rates go up, it makes the bond price go down and the currency will go down also for some reason. Y=1+1 = 2 So if a currency has positive currency correlation that means that as interest rates go up, it makes the bond price go down and the currency will go up for some reason. The position will be hedged. Y=-1+1 = 0
thanks guys … even i had trouble understanding this concept… it seems clearer now with your examples @ CFAdummy… Forget interest rates here… just think in terms of currency. your exposure would be twice if the local currency ( the currency in which you assets are denominated) has a perfectly positive correlation to your domestic currency and your exposure would be zero if the local currency has a perfectly -ve correlation hope i am right here…
Y is your currency exposure in the ICAPM. You multiply it by the appropriate FCRP.