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Currency Exposure - Frequent Questions Answered

  1. Do I have dollar exposure when I buy US stocks ?
  2. Do I avoid currency exposure by staying in Euro-zone stocks ?
  3. Can I benefit from a dollar rise if I buy CRH shares on the US stock exchange in dollars rather than in Euros on either the Irish or London stock exchanges ?
  4. What currency risk have I got if I buy a Japanese equity ETF on the London Stock Exchange in Sterling or on the US Stock Exchange in Dollars ?

Do I have dollar exposure when I buy US stocks ? The currency exposure you have depends on where the company is generating its earnings rather than where it is listed. If the US shares you buy are generating the bulk of their earnings in dollars then you have dollar exposure. On the other hand, if you buy a company like McDonalds, which generates a substantial proportion of its earnings overseas, then you are buying diluted dollar exposure. Let us say that McDonalds generates 50% of its earnings in the US and 50% in Euros. If the dollar declines by 10%, then the value of your shares will decline by 10% when translated back into Euros. But the Euros earnings that McDonalds is generating will rise in value by 5% when translated back into dollars and this rise in earnings should be reflected in a similar rise in the share price. The net decline to you, as a Euro-based investor, is therefore only 5%.

Do I avoid currency exposure by staying in Euro-zone stocks ? The quick answer is not really. If you buy Euro denominated stocks that are generating all their earnings in the Euro-zone area then, yes, you will largely have avoided currency risk. However, there are two types of hidden currency risk in Eurozone stocks. The first risk (same as discussed in the first question above) is when you buy a Euro-zone stock that generates a substantial proportion of its earnings in non-Euro areas. CRH, the Irish-based global building materials comnpany, is a good example. It generates circa 60% of its earnings in the US. If the US dollar declines by 10%, this will translate back into a 6% decline in CRH's earnings. A decline in earnings would normally be reflected in a similar decline in its share price. In this case, the currency risk is reflected indirectly through the share price. The second hidden currency risk is exporters - those companies that have their cost base in one country (or currency) but generate their revenues in other currencies. A company based in the Euro-zone which exports into the US will have an earnings base very dependent on the €/$ exchange rate. All in all, currency risk is hard to avoid altogether.

Can I benefit from a dollar rise if I buy CRH shares on the US stock exchange in dollars rather than in Euros on either the Irish or London stock exchanges ? Let us assume that CRH currently earns 100c (Euros) and 50% of those earnings are earned in US dollars and 50% in Euros. If the dollar appreciated by 20% against the Euro then CRH's earnings would rise to 110c (in Euros). All other things being equal, the share price of CRH in Euros would rise by 10% to reflect the rise in earnings, in effect having been lifted simply by the appreciation of the dollar.

In contrast, if I bought the dollar denominated version of CRH's share on the US market then CRH's earnings when converted back to dollars would fall by circa 10% if the dollar appreciated by 20%. This is because the Euro component of earnings (50%) would decline when expressed in dollar terms. All other things being equal, the dollar price of CRH's shares would decline by 10% to reflect the fall in earnings. But you would have gained 20% via the rise of the currency and when you net it out you would be ahead by 10%, the same as the Euro-based investor. The ancillary point is that CRH's shares will benefit from a rise in the dollar no matter what market or currency you buy them in. I hope I have hit the point this time but if still unclear let me know.

What currency risk have I got if I buy a Japanese equity ETF on the London Stock Exchange in Sterling or on the US Stock Exchange in Dollars ? If you buy a Japanese fund then you own Japanese stocks with yen exposure. It does not matter where or in what currency you buy the fund. For example, if you buy a Japan fund quoted in dollars on the US market and the dollar declines by 20% against the Japanese Yen, then the decline in the dollar price of the fund will be offet by the rise in the value of the underlying shares in the fund when they are translated back from Yen to dollars i.e. Yen shares will rise in value when translated back into dollars. If the $/Yen exchange rate declined from 100 to 80, then a Y100,000 portfolio of Japanese  shares would be worth $100,000, and up from $80,000 previously. So the decline in the dollar is offset by a corresponding rise in the dollar value of the Yen holdings in the fund.

Rory Gillen 18th Febuary 2010