To calculate currency contribution why can’t we simply do this -: Beginning Exchange Rate = R1 Ending Exchange Rate = R2 Currency Contribution = (R2-R1) / R1 Using this more direct approach I get the following as currency contributions in Practice Problems 1 and 2. 1. 0.6/6 = 10% (book says 13%) 2. Yen 5/100 = 5% (book says 5.24%) Euro .0204/1 = 2.04% (matches text) What am I doing wrong. Even if I convert the currencies to direct rates instead of indirect I get a discrepancy with the text. AAARGHHHH!!!
The direct approach is wrong. Gain in the Local Currency - Gain in Foreign currency = Currency Contrib. 1. Here you are SKR Investor. So, you need to do Skr Return of Stock - Return of Same stock -\> to find the Currency contrib. SKR Return = (702-600)/600 = 17% Return = [(702/5.4)-(600/6)]/(600/6) = 30% so Currency Contrib = 17% - 30% = -13% Problem 2: You are a US Investor. You need to do USD Return of Japanese Stocks - Yen Return on Japanese Stocks USD Return on Japanese Shares = (20952-20000)/20000 = 4.76% Yen Return on Jap Stocks = (2200-2000)/2000 = 10% so Currency Contrib of jap stocks = 4.76 - 10 = -5.24%
I understand how the text does it but the currency approach should work as well. The % change in the value of the currency is the currency contribution. I’m wondering if it’s not working because of a rounding error.
not rounding error. the translation effect as well as the economic effect. both the original portfolio is changing in value as well as the exchange rate is changing. so rFx = rLocal + RCurrency + rLocal * Rcurrency. if you take the rLocal * RCurrency to be small (cross product) then rFx = rLocal + RCurrency.
direct approach is appropriate for princial only must consider the cross-product term princial and capital gain/loss am i wrong ?