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General_Magician Special user United States 707 Posts |
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Buying securities denominated in currencies other than your domestic currency creates currency risk; it doesn't hedge currency risk. By keeping all your investments in domestic stock, you are putting all your eggs in one basket with only your domestic currency. You have got to hedge against your own domestic currency too. Not only that, but having investments denominated in various different multiple currencies adds some layers of diversification. Here is a link that explains: Quote:
One of the key factors affecting returns is how currencies behave in relation to other countries. And because currencies tend to move in different directions, when the US dollar is declining, investments in international companies can help boost returns. Of course, the reverse is also true—when the dollar goes up, international investments tend to underperform. http://www.schwab.com/public/schwab/nn/a......tionally Here is a link directly from the US government's SEC: Quote:
What are the special risks in international investing? http://www.sec.gov/investor/pubs/ininvest.htm The US currency can decline too and if you all you are invested in is US domestic markets, then you have that risk that you just put all your eggs in one basket with just the US currency, you are not really preserving your wealth. If you read my last post, you would see my portfolio consists of 28% international securities. The other 72% being US securities.
"Never fear shadows. They simply mean there is a light shining somewhere nearby." -unknown
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General_Magician Special user United States 707 Posts |
Another example I can use, which is an example of some of my own personal experience, of the risk of keeping all your money in your own domestic currency, is what I saw in Bosnia when I was deployed over there years and years ago. The Bosnians at the time used the German Mark instead of their own domestic currency (this was before the Euro was in circulation in Europe). Their own domestic currency was unstable and too risky to use. So, in investing, you have to hedge against your own domestic currency as well (of course the US currency is much more stable but there is still a risk with any currency). I found this link on Wikipedia in regards to currency substitution:
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High and unanticipated inflation rates decrease the demand for domestic money and raise the demand for alternative assets, including foreign currency and assets dominated by foreign currency. This phenomenon is called the "flight from domestic money". It results in a rapid and sizable process of currency substitution.[30] In countries with high inflation rates, the domestic currency tends to be gradually displaced by a stable currency. At the beginning of this process, the store-of-value function of the domestic currency is replaced by the foreign currency. Then, the unit-of-account function of the domestic currency is displaced when many prices are quoted in a foreign currency. A prolonged period of high inflation will induce the domestic currency to lose its function as medium of exchange when the public carries out many transactions in foreign currency.[31] http://en.wikipedia.org/wiki/Currency_su......ic_money
"Never fear shadows. They simply mean there is a light shining somewhere nearby." -unknown
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S2000magician Inner circle Yorba Linda, CA 3465 Posts |
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On Aug 6, 2014, General_Magician wrote: And during periods when the the foreign currency is weak, that weakness decreases your investment return. Thus, your investment return (in your domestic currency) is more volatile than the return in the foreign currency because of the added volatility of currency exchange rates, something that you don't have when you invest solely in securities denominated in your domestic currency. I'm not arguing against investing in foreign securities. All I'm saying is that you're adding currency risk when you do so; you're not hedging currency risk. Are you familiar with interest rate parity and purchasing power parity (both relative and absolute)? |
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General_Magician Special user United States 707 Posts |
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And during periods when the the foreign currency is weak, that weakness decreases your investment return. Thus, your investment return (in your domestic currency) is more volatile than the return in the foreign currency because of the added volatility of currency exchange rates, something that you don't have when you invest solely in securities denominated in your domestic currency. I'm not sure I completely understand what you mean, but to me it makes sense to invest in foreign companies for several reasons, one being that the US dollar can decline in value in comparison to foreign currencies in which case, you get a better return on investment. But you are also correct, your investment returns can go down if the US currency is stronger against foreign currency. But my foreign investments consists of about 28% of my portfolio and are not most of my investments. It seems that when inflation is high in this country like if our country were to print a bunch of money then our currency becomes more unstable in which case it's probably a good idea to own some international stock and enjoy the benefits of what could possibly be a more stable currency. The US government offers inflation adjusted US treasury bonds, but you also take on the credit risk of the US government in owning those securities. In times of high inflation in the US a foreign currency, more accurately might be able to hedge against inflation in the US given that it might not be suffering from inflation like the US currency and you don't take on credit risk with a foreign currency like you would with Inflation Adjusted US Treasury Bonds. Quote:
I'm not arguing against investing in foreign securities. All I'm saying is that you're adding currency risk when you do so; you're not hedging currency risk. I am not sure if I completely understand what you are talking about as far as currency risk (not saying you are wrong now, I am just trying to understand what you are saying). Like, it would seem if you just keep everything in US currency, their is no guarantee that the US currency will always remain stable. I have seen countries that have an unstable currency and then are forced to substitute their own currency with a foreign currency or put a foreign currency into circulation in their local economy because it's a more stable currency and their own domestic currency is unstable (I have been sent to some pretty unstable countries when I was serving in the National Guard). But yes, I agree, aside from currency issues, I think it's a good idea to invest in foreign companies as well. Their are plenty of investment opportunities in the International markets. My ownership in foreign companies is in Vanguard Total International Stock Market Index fund which is part of the fund of index funds I am invested in. I have heard of the terms interest rate parity and purchasing power parity, but I am not familiar with them. I might have studied them one time a long long time ago in a basic economics course or economics 101 course as like knowing the definition of them out of a textbook in school, but I don't know much about the terms.
"Never fear shadows. They simply mean there is a light shining somewhere nearby." -unknown
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General_Magician Special user United States 707 Posts |
S2000,
I found this like on hedging currency. In it, it says one way to hedge against currency risk is to buy foreign currency. When you buy foreign securities like international stocks and bonds, you are also buying foreign currency and not just only ownership into foreign companies or foreign bonds. Here is a quote from the wikihow link: Quote:
quote from wikihow: The above quote is number 3 under Method 3 of 3 for hedging currency. http://www.wikihow.com/Hedge-Currency So basically, by me investing some of my portfolio in International Stock and Bond Index funds, I have hedged the currency risk of my own native currency, which is the US dollar given that by making those purchases into those two international stock and bond index funds, I have purchased foreign currency in addition to my ownership in foreign companies and bonds.
"Never fear shadows. They simply mean there is a light shining somewhere nearby." -unknown
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Dannydoyle Eternal Order 21214 Posts |
What is your hedge against the foreign currency?
Danny Doyle
<BR>Semper Occultus <BR>In a time of universal deceit, telling the truth is a revolutionary act....George Orwell |
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S2000magician Inner circle Yorba Linda, CA 3465 Posts |
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On Aug 6, 2014, General_Magician wrote: Because you're in Atlanta, when you buy things - groceries, thumb tips, cars, whatever - you pay in US dollars (USD). You don't pay in euro (EUR), or on yen (JPY), or in British pounds (GBP); you pay in USD. So the only thing that matters to you is how many USD you have. Suppose that you invest in a stock denominated in EUR, and over the course of a year the investment grows in value by 10%. Suppose that during that year the USD declines in value 6% relative to the EUR. At the end of the year, your return (in USD: the stuff you use to buy things) is (approximately) 4% (= 10% - 6%). Your EUR investment hasn't hedged anything because, in the end, you have to convert it back to USD, your domestic currency; if your currency depreciates, then your investment depreciates, by the same percentage. |
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General_Magician Special user United States 707 Posts |
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Because you're in Atlanta, when you buy things - groceries, thumb tips, cars, whatever - you pay in US dollars (USD). You don't pay in euro (EUR), or on yen (JPY), or in British pounds (GBP); you pay in USD. So the only thing that matters to you is how many USD you have. It seems you are contradicting the wikihow link by arguing that you cannot hedge currency risk by buying some foreign currency. That doesn't make sense. Now, if my investment in an international company, demoninated in Euros grows in value by 10% and I turn around and sell that investment, I get Euros back. Now if the dollar weakens against the Euro and I exchange those Euros, then I get a higher return on investment because I will get even more dollars back given that the Euro is stronger against the dollar. So, in actuality, after converting over from Euros to dollars, my investment actually offers a higher return than 10% because the Euro is stronger and exchanges for more dollars. This is why sometimes when our currency becomes weaker against other foreign currencies it's a good thing for our economy because then foreigners have an incentive to shop in the US because their currency exchanges for more dollars and they have greater purchasing power in the US. So they want to shop here in the US given that they can buy more and that generates more sales for our own companies here in the US given that more foreigners are coming over to shop in the US because they can now buy more. Like here is a currency converter: http://onlinefx.westernunion.com/currenc......SD&amt=1 . If you plug in how many dollars can buy a Euro, one US dollar equals about 75 cents in Eurs (not sure what the equivalent for cents is in the Euro currency). So, things are more expensive for US consumers in Europe given that our currency is weaker than the Euro. However, given that the Euro is stronger against the dollar, one Euro exchanges for $1.34 in US dollars. So that means, Europeans have greater purchasing power in the US given that their currency is stronger and they can exchange out Euros for dollars and get more US dollars in return to buy things in America. So, if I had an investment in a European company that is denominated in Euros and it grew in value by 10%, sold that investment and got Euros back after selling that investment and then turned around and exchanged those Euros from those sold securities for dollars, I get an even greater return because I get even more dollars back when I exchange the Euros for dollars given that one Euro exchanges for $1.34 in US dollars.
"Never fear shadows. They simply mean there is a light shining somewhere nearby." -unknown
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S2000magician Inner circle Yorba Linda, CA 3465 Posts |
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On Aug 6, 2014, General_Magician wrote: If you convert your USD to EUR to invest in an EUR-denominated stock, then convert your EUR back to USD after you sell that stock, you incur the risk that the EUR/USD exchange rate will change. You have added a risk (currency exchange rate risk) that you wouldn't have had had you invested in a USD-denominated stock. If you think that investing in a EUR-denominated stock will somehow mitigate the effect of the USD appreciating or depreciating vis-Ã -vis the EUR, you're mistaken: when that investment ends and you convert your EUR back to USD, you experience the full effect of the change in the EUR/USD exchange rate. You may make higher returns investing in foreign securities, and you may make lower returns, and there is certainly some diversification benefit to investing in foreign securities. But investing in foreign securities does not hedge currency risk; it adds currency risk. |
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S2000magician Inner circle Yorba Linda, CA 3465 Posts |
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On Aug 6, 2014, General_Magician wrote: Respectfully, that's not what it means at all. |
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General_Magician Special user United States 707 Posts |
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You may make higher returns investing in foreign securities, and you may make lower returns, and there is certainly some diversification benefit to investing in foreign securities. But investing in foreign securities does not hedge currency risk; it adds currency risk. I don't agree with you. Every currency has risk and their is no guarantee that any one currency will remain stable and this includes the US currency. I have seen this happen in foreign countries where their currency becomes so unstable, they pretty much have to substitute a foreign currency in place of their own native currency. So, keeping all your holdings in our native currency is like putting all your eggs in one basket. That's not a smart move. Part of the value of diversification is that it hedges against various risks, including currency risk. If you hold everything in just one currency, you have currency risk even if it's just one currency because their is always the risk your own native currency can become unstable. Every currency carries a risk even if you just hold one currency. I mean your native currency can experience runaway hper-inflation like what happened in Bosnia for example when that country went to hell in a handbasket with the violent breakup of the former Yugoslavia and the people started substituting a foreign currency, the German Mark, in place of or alongside their native currency. Their native currency was experiencing hyper inflation and just wasn't stable. Those that kept their holdings in their native currency in Bosnia at the time had their wealth completely wiped out by the runaway hyper inflation. I am sure if you told the Bosnians at that time that they had no risk by holding on to their native currency, they would have strongly disagreed with you and thought you were crazy. Quote:
Respectfully, that's not what it means at all. Then what does it mean? How can it not mean that? I have been on the French Canadian border (used to live on the French Canadian border and my wife is from there) and I have been told that the French Canadians come on down to shop in the US (and I have seen them shop here in the US personally), especially in cases where their dollar is stronger against our dollar because they can buy more. I'm sure I didn't imagine any of this and certainly makes a lot of sense to me as I sm sure it would to most people. Maybe the Canadians can chime in and offers some insights. I mean, I wonder if you are seriously disagreeing with me, or are simply pretending to disagree with me. I'm not sure. I am honestly beginning to wonder.
"Never fear shadows. They simply mean there is a light shining somewhere nearby." -unknown
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LobowolfXXX Inner circle La Famiglia 1196 Posts |
Will you go to Europe and shop with Euros if the U.S. Dollar drops relative to the Euro and you have European stocks?
"Torture doesn't work" lol
Guess they forgot to tell Bill Buckley. "...as we reason and love, we are able to hope. And hope enables us to resist those things that would enslave us." |
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General_Magician Special user United States 707 Posts |
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On Aug 6, 2014, LobowolfXXX wrote: I'm not sure why owning European stocks would necessarily have a bearing as to why I would or would not shop in Europe, but if the US dollar was weaker against the Euro, I certainly would not want to shop in Europe because I would get less Euros for my dollars. I'm trying to follow you guys here, I'm not following you and I am beginning to wonder if you guys are just joking around. I think what I am saying makes perfect sense to me and would for most people. I am not trying to be argumentative here, but I am honestly not following you guys here. Here is an investopedia link. I am interested in seeing some data from S2000 to support his assertions: Quote:
How Do Multinationals Benefit When the Dollar Falls? http://www.investopedia.com/articles/eco......alls.asp The case in the above example would be the same if it was an international company you invested in and that international company made money and went up in value and then you sold and converted those earnings back to US dollars when that international company's currency was stronger against the US dollar. You would make even more because when you convert back, you get more US dollars on top of the profit made from the international company. Otherwise, I am beginning to think this isn't really a serious discussion at all and that you guys are just playing devil's advocate or something or just trying to play or troll around.
"Never fear shadows. They simply mean there is a light shining somewhere nearby." -unknown
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Dannydoyle Eternal Order 21214 Posts |
Anyone want to buy a donkey? Rent one perhaps? I haven't a few windmill prospect.
You don't agree? Really? What was so kindly given to you was not a matter of opinion William it was a mathematical fact. He said effectively 2 added to 2 is 4 and you said you don't agree. Read what was written again. It is not an opinion. Unless you leave your earnings in EUR and buy with EUR you have conversation risk.
Danny Doyle
<BR>Semper Occultus <BR>In a time of universal deceit, telling the truth is a revolutionary act....George Orwell |
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LobowolfXXX Inner circle La Famiglia 1196 Posts |
I doubt that anyone posting in this thread knows more than Bill (S2000) about finance, and I'm quite positive that nobody here knows much more, and he doesn't troll.
"Torture doesn't work" lol
Guess they forgot to tell Bill Buckley. "...as we reason and love, we are able to hope. And hope enables us to resist those things that would enslave us." |
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General_Magician Special user United States 707 Posts |
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On Aug 6, 2014, LobowolfXXX wrote: I mean, I honestly wasn't sure. But do you see where my point of view comes from? Does it make sense? I mean, I am here to tell you, their is no guarantee that any country's currency will remain stable, not even our own currency. Maybe technically Bill is correct in what he said. I am just trying to understand his point of view and WHY he disagrees with me. My point of view seems to make very good logical sense to me. I mean if Bill can make a compelling case that makes sense that shows why I am wrong, then sure, I will agree with him. I'm not too proud. But it's got to make sense. If he can't make a compelling case that makes sense as to why I am wrong, just because he says I am wrong, doesn't mean I am and just because he is some kind of finance professor doesn't make him right automatically. He still has to back up what he says with a compelling case that makes sense. I have seen some pretty smart professors turn out to be wrong in their own field and I mean no disrespect to anybody here. But to me, this seems rather simple and you don't need to be some kind of Ph D in finance to understand it. Just like in the Wikihow link, it shows one of the ways to hedge against currency risk is to buy foreign currency, yet Bill says this isn't true. Yet, when I gather up all the facts concerning the matter, I am forced to conclude that logically, it is true.
"Never fear shadows. They simply mean there is a light shining somewhere nearby." -unknown
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S2000magician Inner circle Yorba Linda, CA 3465 Posts |
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On Aug 6, 2014, General_Magician wrote: I'm not surprised. But that doesn't mean that I'm wrong. Quote:
On Aug 6, 2014, General_Magician wrote: It sounds as though when you use the phrase "currency risk", you mean "inflation risk". Is that correct? If not, then what, exactly, do you mean by "currency risk"? Quote:
On Aug 6, 2014, General_Magician wrote: There's a difference between a reserve currency like the US dollar and non-reserve currencies like the Yugoslavian dinar. I wouldn't advocate holding rubles, or rupees, or bhat, or real, or a host of other currencies. But if your domestic currency is a reserve currency (e.g., USD, EUR), there's little risk of hyperinflation. Again, it sounds as though you’re saying "currency risk" when you mean "inflation risk". Quote:
On Aug 6, 2014, General_Magician wrote: So, are you saying that US products are 100 times as expensive to Japanese consumers as they are to American consumers because the exchange rate is JPY102 per USD1.0? Are US products more expensive if you price them in pennies than if you price them in dollars? Whether a currency is strong or weak (vis-a-vis another currency) depends only on how the exchange rate changes, not on the absolute level of that exchange rate. Whether this makes sense or not to most people isn't relevant; what's relevant is whether or not it's true. |
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S2000magician Inner circle Yorba Linda, CA 3465 Posts |
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On Aug 6, 2014, General_Magician wrote: Let's examine why the EUR is strong against the USD, which first requires that we understand what "the EUR is strong against the USD" means. Saying that the EUR is strong against the USD means that the EUR is appreciating vis-a-vis the USD; i.e., the number of USD per EUR is increasing. Why would it be increasing? The most common reason is an inflation differential: inflation in the US is higher than inflation in the Eurozone. This is explained by purchasing power parity (PPP). Another possible reason is a difference in real interest rates: real interest rates in the US are higher than real interest rates in the Eurozone. This is explained by (real) interest rate parity (IRP). Real interest rates in developed economies rarely differ by much, so we'll go with the inflation explanation. When the US company converts its EUR to USD (and gets more USD because of the change in the exchange rate), the Investopedia article describes that as a "nice jolt to the bottom line." What the article fails to mention is that that jolt consists of USD that have lower purchasing power than the original USD (because of inflation), and that, because of inflation, the company's domestic sales will experience exactly the same jolt. It's just inflation: the jolt isn't real. (By the way, I wouldn't choose Investopedia as my first source when trying to understand complex financial or economic ideas; there are many errors in Investopedia (i.e., fundamental misunderstandings). As a simple example, their explanation of beta is full of errors.) |
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balducci Loyal user Canada 227 Posts |
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On Aug 6, 2014, S2000magician wrote: I must admit I am a little puzzled by your example. Perhaps you mistyped one of your assumptions? Or I am misreading something? Suppose currency A is equal to currency B at the start of the period. I convert 100 units of A to B, and purchase an investment in currency B. It grows to 110 units in B. At the end I sell it and convert back to A. 110 divided by 0.94 is 117.02. (Same assumptions you stated, but with A and B in place of USD and EUR.) So I don't see where you get the 4% return in USD from. Perhaps your implicit meaning here is that when you adjust for changes in market prices in goods and services priced in currency A you are not as far ahead as you think? The significance of that in practical terms is not completely straightforward in the real world though, I think. At the very least the adjustment is often not immediate, and may take place over a significant period of time (depending on the particular goods and services).
Make America Great Again! - Trump in 2020 ... "We're a capitalistic society. I go into business, I don't make it, I go bankrupt. They're not going to bail me out. I've been on welfare and food stamps. Did anyone help me? No." - Craig T. Nelson, actor.
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balducci Loyal user Canada 227 Posts |
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On Aug 6, 2014, Dannydoyle wrote: Conversation risk has more to do with forum posts.
Make America Great Again! - Trump in 2020 ... "We're a capitalistic society. I go into business, I don't make it, I go bankrupt. They're not going to bail me out. I've been on welfare and food stamps. Did anyone help me? No." - Craig T. Nelson, actor.
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