Currency risk - Risk

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Из курса от партнера University of Geneva

Portfolio and Risk Management

866 оценки

University of Geneva

Portfolio and Risk Management

866 оценки

Курс 3 из 5 — Specialization Investment Management

In this course, you will gain an understanding of the theory underlying optimal portfolio construction, the different ways portfolios are actually built in practice and how to measure and manage the risk of such portfolios. You will start by studying how imperfect correlation between assets leads to diversified and optimal portfolios as well as the consequences in terms of asset pricing. Then, you will learn how to shape an investor's profile and build an adequate portfolio by combining strategic and tactical asset allocations. Finally, you will have a more in-depth look at risk: its different facets and the appropriate tools and techniques to measure it, manage it and hedge it. Key speakers from UBS, our corporate partner, will regularly add a practical perspective on these different topics as you progress through the course.

Из урока

Risk Management

This fourth and final week is dedicated to risk. We will start by looking in more depth at different sources of risk such as illiquidity and currency risk but also at the different tools available to investors to perform risk management. But how should we measure risk? We will see that it may be valuable to go a step beyond standard deviation, the risk measure we used so far, and look at the Value-at-Risk and Expected Shortfall which focus on potential large losses. Finally, we will use the financial instruments at our disposal to hedge market and currency risk.

Defining forwards and options - Forwards10:08

Defining forwards and options - Options11:44

Risk as volatility?4:21

What about illiquidity? - UBS guest speaker2:56

Currency risk - Return7:35

Currency risk - Risk6:11

Познакомьтесь с преподавателями

University of Geneva- Tony Berrada
SFI Associate Professor of Finance
Geneva Finance Research Institute
University of Geneva- Ines Chaieb
SFI Associate Professor of Finance
Geneva Finance Research Institute
University of Geneva- Jonas Demaurex
Teaching Assistant
Geneva Finance Research Institute
University of Geneva- Rajna Gibson Brandon
SFI Senior Chaired Professor of Finance and Managing Director of the GFRI
Geneva Finance Research Institute
University of Geneva- Michel Girardin
Lecturer in Macro-Finance - Project Leader for the "Investment Management" specialization
Geneva Finance Research Institute
University of Geneva- Philipp Krueger
SFI Assistant Professor of Finance
Geneva Finance Research Institute
University of Geneva- Kerstin Preuschoff
Associate Professor of Neurofinance and Neuroeconomics
Geneva Finance Research Institute
University of Geneva- Olivier Scaillet
SFI Senior Chaired Professor of Finance and Vice-dean (research) at GSEM
Geneva Finance Research Institute

[MUSIC]

Let's now look at some real data and see to what extent the currency will

contribute to the return of your foreign investment.

A typical benchmark used to assess the performance of foreign equity,

non-US Equity is the EAFE index that stands for Europe,

Australasia, Far East index provided by MCI.

And here in this plot in gold, you see the foreign currency return and

in green, you see the currency return contribution.

And the sum of the gold and green will give you the dollar return.

Look at 2003.

Almost half of your dollar return is due to this favorable move

of the foreign currency.

So depreciation of the foreign currency is [INAUDIBLE] a dollar,

or likewise the depreciation of the dollar is [INAUDIBLE] other currencies.

But in '97 it was the other way around.

You almost lost all of the gain you made in the foreign

equity because of the depreciation of the foreign currency against the dollar.

So, when you see this you might say wow, I should not go and

invest in foreign markets because I can get a lot of exposure to currency.

This is wrong.

Remember you can gain a lot by investing abroad and

you can manage this risk if you don't like it.

In next video we'll see how you can manage currency risk.

Now let's move on and

see how this currency now contributes to the risk of your portfolio.

So far we have been seeing the contribution to the return.

Now we move to the risk.

The variance of the dollar return

is equal to the variance of the foreign currency return.

Plus the variance of the change in exchange rate plus twice the correlation

between the foreign currency return and the exchange rate changes.

And times the standard deviations for foreign currency and of the exchange rate.

So see here that dollar return volatility is not

just the sum of the foreign currency volatility and

the exchange rate volatility.

The risk is not additive which is good for us because of the less than

perfect correlation between that exchange rate and the foreign currency return.

The currency risk contribution is simply the difference between the volatility

of the dollar return and the volatility of the foreign currency return.

Let's take an example.

A foreign investment has a volatility of 20%,

let's assume that the exchange rate changes volatility is 10%.

The correlation between the exchange rate changes.

And the foreign currency return is at 0.

So what would be the risk in domestic currency and

the contribution of currency risk.

Is it A, the risk in domestic currency is 30% and currency risk contribution is 10%.

Or is it B, the risk in domestic currency is 22.4% and

currency risk contribution is 2.4%.

If you answered A, you didn't get it right.

You thought that you can simply add up the two risks,

the 20% and the 10% and forgot about the correlation.

So if you compute the variance of the dollar return, that's the 20% squared plus

the 10% squared, and twice the correlation times the standard deviation, but

the correlation here is zero.

So you end up with the 20% squared plus a 10% squared, and you take

the square root of this sum and you end up with a volatility of simply 22.4%.

And a risk contribution then of 22.4 minus the 20 which means 2.4%.

So the right answer is b.

Let's see now with some real data what is the currency risk

contribution to your portfolio.

And here we'll distinguish between equity and bonds, specifically sovereign bonds.

What you see here is the first column shows you the foreign return risk, so

the percentage of the risk that is due to the changes in foreign returns.

And the second column shows you the currency risk.

Better the same calculation that we did but

this is expressing percentage of the total risk, okay?

So you see that for all of these markets, whether developed or

emerging, the contribution of currency risk is rather small

over this period that lies from 1990 to 2013.

And that's in general the case.

It is a little bit higher notice for

emerging markets because of the higher volatility of that currencies.

But you see that the large part of the variation is due to the variation

in the foreign returns.

For sovereign bonds it's different.

A large part of the variation is due to the fluctuation of exchange rates.

So you're now able to calculate the return and

volatility of a foreign asset in your domestic currency and

to measure how changes in exchange rates could affect return and

risk of your foreign investment.

If you dislike currency risks, don't think I'm not investing globally, just

remember that you can hatch this risk and that's what we'll see in the next video.

[MUSIC]

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