How does the stock affect the currency

Exchange rate risk: How the currency affects the investment

If the price of an investment is set in a foreign currency, you are not only exposed to exchange rate risks with this investment, but also exchange rate risks at the same time. You can find out exactly what this looks like and when you should minimize the currency risk here.

Simply and briefly explained: currency risk

A currency risk, also an exchange rate risk, occurs when a transaction takes place in a foreign currency. If you make an investment in a currency other than the euro, there is a risk that the exchange rate will change to your disadvantage. Your investment may be worth less if you sell the security. The further apart buying and selling are in time, the greater the risk.

Formation of the courses

The exchange rates are in international currency trading formed, for example through cross-border lending and foreign investments. Supply and demand for individual currencies define their value. Ultimately, every single purchase of a product abroad has an, albeit mostly negligible, influence on an exchange rate. The exchange rates therefore fluctuate constantly.

Who does the risk affect?

The fluctuations have an impact wherever business is done between countries with different currencies. This affects merchants as well as creditors, but also everyone who trade securities.

For example, if you buy a share in a foreign currency, then at least hit in the investmenttwo currencies on each other. These are related to each other. This means that they form their value depending on the other currency. For example, the value of the US dollar can be given in euros, and vice versa. In this way, one currency can go down or up in value against another. For example, they say: "One euro is currently worth 1.20 dollars."

Examples of currency opportunities and risks

For investors, changes in exchange rates create the risk that they will achieve less return on an investment. That sounds very abstract at first. That's why we've put together all possible cases for you here. Be theretwo scenarios under the microscope:

  • In the first case, the increase in the value of the foreign currency,
  • in the second the depreciation of the foreign currency.

In these cases, the foreign currency is the currency in which the investment is made. Our example is a trade in US dollars.

Scenario 1: The value of the foreign currency increases

The following scenario: Max buys 14 stocks that are listed in US dollars. Each share costs $ 100, so they're worth $ 1,400 in total. The valid US dollar to euro exchange rate is enclosed1,4:1. So in this case the euro is very strong. For every euro invested, Max receives $ 1.40. This means that he can buy the securities worth $ 1,400 for 1,000 euros.

After a while, Max would like to sell his shares. For the sake of simplicity, we assume that your market price has not changed in the meantime. So combined, they're still at $ 1,400. (In practice, of course, this is rather unlikely.)

In the meantime, the exchange rate of the two currencies has changed. Now it's just included1,2:1. So one euro is worth 1.20 dollars. Compared to the time of purchase, the dollar has thus gained against the euro. When the securities are sold, they are converted back into euros at the current exchange rate. And since the dollar has risen so sharply - that is, it is worth more euros than before - Max now receives 1,167 euros for the 1,400 US dollars. The favorable exchange rate change gives him one Profit of 167 euros. And that despite an unchanged share price.

Scenario 2: The value of the foreign currency is falling

And now the reverse case: The same requirements apply. At an exchange rate of 1.4: 1, Max bought US stocks worth $ 1,400. Again, the stock price doesn't change, it sells for an amount of $ 1,400.

But this time the euro has gained further against the dollar - so it is worth even more US dollars. The current course is attached1,6:1. So that's the Value of the shares so - calculated in euros - decreased because the dollar has lost. If the original currency is converted when a sale is made, Max only receives 875 euros. So he does 125 euros loss.

Investor tip

So if you invest in securities that are quoted in foreign currency, you should keep looking at them current exchange rates throw. In this way, additional returns can sometimes be achieved or unnecessary losses can be avoided. The following applies: If the exchange rate of the foreign currency in which a security is quoted increases, the return also increases. If the foreign currency falls, however, the return falls.

Effects on various investments

As you can see from the two examples, there are always exchange rate risks Exchange rate opportunities. Whether you buy stocks, bonds, funds or commodities - all of these investments are subject to exchange rate risk if they are not in euros.

Commodities, for example, are mostly quoted in US dollars. The exchange rate risk is therefore inevitable for German investors. In the case of stocks and bonds, on the other hand, it depends on the currency in which a security is traded. If you invest the euro in your home currency, there is no additional currency risk, but there is in all other currencies.

Stocks and funds

Exchange rate uncertainty plays less of a role with stocks and equity funds than with some other investments because it can be designed more flexibly. When you get out and sell is entirely up to you. So, ideally, you can sell when the exchange rate is favorable. Because currency ratesno long trends follow, it is quite possible that a currency rate, which is still unfavorable now, will be quoted completely differently in the next year. So a little patience often pays off.

Another reason why equity investments are less affected by exchange rate risks results from theglobal activity of companies. Suppose a European investor holds shares in a US company. The dollar rises during this period. So it makes profits just from the rising dollar exchange rate. But at the same time, the increased dollar exchange rate also means that the company can export less, because foreign buyers shy away from the high costs. That depresses the share price. Exchange rate and share price effects often cancel each other out.

Protect your commodity investments through hedging

Commodity prices will bemostly in US dollars determined. If you buy a commodity in this country through your broker, for example gold, there is a currency risk. Since commodity investments tend to take place over short-term periods and are very dependent on the foreign currency, it usually makes sense to hedge the investment against changes in exchange rates.

The technical term for such a currency hedge isHedging. To secure your gold investment, you can, for example, buy special certificates on gold that have been expanded to include a hedging component. Note, however: Any exchange rate risk is excluded; but at the same time also the exchange rate opportunities. After all, the course could also develop in your favor.

If you invest in raw materials, you should therefore ask yourself whether you want to rely exclusively on the price of the raw material for your investment or indirectly on the exchange rate as well. Depending on what you choose, you could, for example, buy a gold certificate with or without a hedging component.

Beware of bonds and bond funds

Even if you invest in bonds and pension funds, you should factor exchange rate uncertainties into your return expectations. AtDollar bonds for example, a fall in the rate of the dollar means a loss. At the end of the term, you will still receive exactly the nominal value of the bond that you invested at some point - but if the dollar rate has fallen by five percent against the euro, the payout in dollars is correspondingly less worthwhile.

Thefixed term of bonds can become a problem here. Because you can't just wait until the exchange rates have recovered before selling. A ten-year bond must be returned after this time at the latest. Investors in the bond market should therefore think about either buying Eurobonds straight away or investing in hedged bond funds. An alternative is to sell the bonds on the stock exchange before the end of their term if there are indications of a longer unfavorable exchange rate trend.

Exchange rate: not always a risk

Whether the exchange rate between local currency and foreign currency can be a problem for you depends a lot on how you invest. For commodities and bonds, it can make sense to hedge against market risk. If, on the other hand, there are only stocks and equity funds in your portfolio, you can confidently do without additional protection. When selling the shares, however, pay attention not only to the share price, but also to the current exchange rate. So you can make your planned sale a little earlier or later if necessary.

Saskia has a doctorate in German and has been working in finance since 2017. Her main focus is on securities accounts as well as accident and death benefit insurance.

Latest articles by Dr. Saskia Gall read:

Saskia has a doctorate in German and has been working in finance since 2017. Her main focus is on securities accounts as well as accident and death benefit insurance.

More articles from Dr. Saskia Gall read:

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