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Currency Investing 101, Part 2 of 2

Frank Trotter | December 1, 2015 2 MIN READ

Last month, in part 1 of this series on currency investing basics, we touched on some of the key factors to consider when weighing one foreign currency against another. If you happened to miss it, you can check it out here. Today, we’re turning our attention to the stuff that really gets us excited—the numbers.

Most people understand the basics of investing in stocks: you buy a stock, the price moves up or down, you sell it for either a gain or a loss, and that’s that. Determining a gain or loss from currencies is pretty similar and nearly as simple, but the following example should help to paint an even clearer picture.

INVESTING IN THE BRITISH POUND

Let’s assume the following1

$15,000 U.S.
TOTAL INVESTMENT
$1.50 U.S.
NET PURCHASE PRICE/POUND
10,000 GBP
TOTAL POUNDS PURCHASED
1-YR CD
INVESTMENT PRODUCT

THREE HYPOTHETICAL RESULTS

Here are three performance scenarios of the 1-yr CD. One where the pound weakens against the dollar, one where it stays the same, and one where it strengthens.

TRICKLE DOWN IMPACTS

In addition to adding diversification to a portfolio, currencies can be used as a hedge against cost increases from another country. For example, through the early part of the 2000s, as the value of the euro rose against the U.S. dollar, importers of products from Europe had to pay higher prices in U.S. dollars to purchase the goods. Higher prices that were in turn passed along to consumers.

Let’s say a container full of widgets costs 100,000 euros from the manufacturer. In the early 2000s, the euro traded as low as $0.90 per euro, so the importer would have paid $90K for the container. Later in the decade, the euro was priced at $1.50 U.S. (and higher) per euro, so that same container would have cost $150K. This is a quiet but important increase in cost to the consumer.

Many investors use currencies to hedge against just these types of price impacts. In the scenario above, consider a situation in which an investor had previously invested in the euro. That investor could have utilized this gain on the currency, and their investment, to help offset the price increases incurred domestically on items imported from Europe.

A FEW FINAL WORDS, IN PLAIN ENGLISH

What we’re talking about here is not the same as foreign currency trading, or forex as it’s often called. Forex traders speculate on short-term market moves. It’s risky by nature and often unsuccessful, though some do make it work. With currency investing, we’re striving for a stronger diversification strategy that has the potential to reward us with both monetary returns and a hedging solution.

While this may or may not be the right thing for you, many investors do take advantage of currencies when building their portfolios, and many have been very pleased with the results.

Frank Trotter
Frank Trotter
Executive Vice President, Chairman Global Markets
Frank Trotter
Frank Trotter
Executive Vice President, Chairman Global Markets
Frank has over 35 years of experience in banking and global markets. When not in the office, you might find him speaking on the financial conference circuit, giving an interview on the latest world economic news, or at the nearest ice rink playing pick-up hockey.

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  1. Assumes reader purchases or sells at this value net of all charges. Price, charges, and spread will vary widely by institution or individual buying or selling the currency.