I am an European, earning my salary in Euro and trading in US-securities. My strategies are a combination of momentum investments and monthly saving plans, where I invest a fixed percentage of my salary in regular intervals into a Nasdaq100 ETF.

How can I calculate my currency risk exposure and how can I hedge against it?


How can I calculate my currency risk exposure?

You own securities that are priced in dollars, so your currency risk is the amount (all else being equal) that your portfolio drops if the dollar depreciates relative to the Euro between now and the time that you plan to cash out your investments. Not all stocks, though, have a high correlation relative to the dollar. Many US companies (e.g. Apple) do a lot of business in foreign countries and do not necessarily move in line with the Dollar. Calculate the correlation (using Excel or other statistical programs) between the returns of your portfolio and the change in FX rate between the Dollar and Euro to see how well your portfolio correlated with that FX rate. That would tell you how much risk you need to mitigate.

how can I hedge against it?

There are various Currency ETFs that will track the USD/EUR exchange rate, so one option could be to buy some of those to offset your currency risk calculated above. Note that ETFs do have fees associated with them, although they should be fairly small (one I looked at had a 0.4% fee, which isn't terrible but isn't nothing).

Also note that there are ETFs that employ currency risk mitigation internally - including one on the Nasdaq 100 .

Note that this is NOT a recommendation for this ETF - just letting you know about alternative products that MIGHT meet your needs.

  • Good point about the correlation between US assets & the USD - it will not be a perfect 1:1 correlation where the particular asset you are investing in is involved with foreign currencies in one way or another. Apr 24 '17 at 14:05
  • @Grade'Eh'Bacon Some types of industries can benefit from a cheaper dollar (e.g. agriculture) so the correlation may actually be negative.
    – JimmyJames
    Apr 24 '17 at 16:15
  • Placing a cheap bet on a weakening dollar would be the most straight-forward way to hedge. This seems to me to be the only legitimate reason the average investor should consider on of these ETFs. The math to figure out exactly how much to buy is non-obvious. There is also some risk that a really strong dollar could tank your stocks and your currency bet though.
    – JimmyJames
    Apr 24 '17 at 16:22

You can calculate your exposure intuitively, by calculating your 'fx sensitivity'. Take your total USD assets, let's assume $50k. Convert to EUR at the current rate, let's assume 1 EUR : 1.1 USD, resulting in 45.5k EUR . If the USD strengthens by 1%, this moves to a rate of ~1.09, resulting in 46k EUR value for the same 50k of USD investments. From this you can see that for every 1% the USD strengthens, you gain 500 EUR. For every 1% the USD weakens, you lose 500 EUR.

The simplest way to reduce your exchange rate risk exposure, is to simply eliminate your foreign currency investments. ie: if you do not want to be exposed to fluctuations in the USD, invest in EUR only. This will align your assets with the currency of your future expenses [assuming you intend to continue living in Europe].This is not possible of course, if you would like to maintain investments in US assets.

One relatively simple method available to invest in the US, without gaining an exposure to the USD, is to invest in USD assets only with money borrowed in USD. ie: if you borrow $50k USD, and invest $50k in the US stock market, then your new investments will be in the same currency as your debt. Therefore if the USD strengthens, your assets increase in relative EUR value, and your debt becomes more expensive. These two impacts wash out, leaving you with no net exposure to the value of the USD.

There is a risk to this option - you are investing with a higher 'financial leverage' ratio. Using borrowed money to invest increases your risk; if your investments fall in value, you still need to make the periodic interest payments. Many people view this increased risk as a reason to never invest with borrowed money. You are compensated for that risk, by increased returns [because you have the ability to earn investment income without contributing any additional money of your own]. Whether the risk is worth it to you will depend on many factors - you should search this site and others on the topic to learn more about what those risks mean.

  • Thanks a lot for your good explanation. I had to pick one answer though and I picked the second one because it contained a link to a currency hedged ETF. Apr 24 '17 at 16:22

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