Week 5_Exchange Rate Risk _ Note by Prof Wang

Week 5_Exchange Rate Risk _ Note by Prof Wang - Kevin Q....

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A supplement note Kevin Q. Wang MGT 330 INVESTMENTS Exchange Rate Risk 1 1. International Investments Suppose you have a U.S. dollar bank account and you are considering investing in the U.K. stock market. One thing you are sure about is that you want to put the proceeds (in British pounds) from the investment back to the U.S. dollar account. How is your return related to the exchange rate? Let’s write your return from doing so as ˜ r $ ,the dollar return . In general, it is di f erent from the local return ˜ r BP on the British stock market. This is because when you invest in theU .K . ,youneedto f rst exchange dollars into pounds at today’s rate, and then change the pounds back into dollars at some point in the future when you are done investing in the U.K. Let’s say that today’s exchange rate is e 0 dollars per pound, and the rate at the end of the investment period is ˜ e 1 dollars per pound. De f ne ˜ e $ /BP = ˜ e 1 e 0 e 0 , which is the percentage change in the dollar/pound exchange rate. For example, if e 0 =1 . 4 ($/BP) and if the dollar becomes weaker over the period such that ˜ e 1 =1 . 5, then ˜ e $ /BP = 7 . 1%, an upward 7
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Week 5_Exchange Rate Risk _ Note by Prof Wang - Kevin Q....

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