What is the Impact of Currency Exchange Rates on Investment?
Generally, people believe that changes in the currency exchange rate will not affect them unless they are purchasing something imported, planning a holiday in a foreign land, or investing in currencies. However, this is not true.
Fluctuations in exchange rates can have a direct impact on your financial investments in many ways. How do currency exchange rates affect investment? Read on to find out!
What Causes Fluctuations in Currencies?
Predicting the movement of currencies is a risky business. A political event or an economic data release can result in a short-term jump or slip in a currency. However, in the long term, there are other main drivers of foreign, market trends, or foreign exchange.
The main driver is the strength of an economy or its perception of the market. A strong economy implies stronger currency. This is because global investors feel more confident in a country’s prospects and tend to purchase more assets in that currency.
Investors will be more inclined if interest rates seem likely to rise. Higher interest rates signal a higher yield on the assets, which makes them more appealing. The movement of the currency is also determined by the trading relationship of a company. Countries that export more than imports have stronger currencies, boosted by the demand in the market for their goods.
What is Exchange Rate Fluctuation?
The exchange rate is the rate at which a nation’s currency may be converted into the currency of another nation. For example, if the US dollar/ Rupee exchange rate is 75.86, then you will have to spend INR 75.86 to buy the US $1.
This exchange rate fluctuates every day due to the currency market trading around the world (24*7 five days a week). The demand-supply dynamics in the market push up or pull down the exchange rate of a nation’s currency as compared to another currency.
Even if you are not involved in any kind of currency investment, the fluctuations can have a significant impact on your bond or stock market investments in two ways:
Investment in International Financial Market
Let’s say you are an Indian and you have invested in the stock of a company listed in the United States. You purchased the stock in dollars and are waiting for the share price to appreciate by 10% due to an upcoming event that is expected to be a game-changer for the company in the United States.
Suppose the price of the stock gets appreciated by 10% after a month. But at the same time, the dollar gets weakened against the US dollar by 10%. In this case, you will get a 10% return on your investment. However, when you convert the profit (in dollars) back into rupees and transfer the amount into your bank account, the net return could turn out to be negative due to currency fluctuations.
This same thing may happen if you invest in any type of international asset class. The profit or loss may be high or low based on the currency rate movement.
Investment in Domestic Market
If you invest in the shares of Indian companies, you will still get impacted by the fluctuations in the currency exchange rate. Let’s say you buy a share of a company (in Indian rupees). This company gets half of its earnings from foreign operations in the US.
If the rupee weakens 10% against the US dollar, the company’s earnings will get affected. The profit from operations in the US would get reduced by 10%. This implies that the total profit of the company would get redacted by 5% from both international and domestic markets.
Let’s take another example. Suppose the company does not have any presence in the US, but it imports its raw materials from there. In this case, the cost would increase when the rupee weakens against the US dollar as the company would have to pay more for buying the raw materials.
Therefore, we can say that the rise and fall of the Indian rupee will affect the earnings of Indian companies in multiple ways. The impact will reflect in their stock prices and dividends and the portfolios of the investors.
Impact on Mutual Funds
If you have invested in a mutual fund and the fund manager has invested your money in foreign bonds or stocks, the up or down movement of currency will determine how your investment in the mutual fund will perform.
Your foreign mutual fund investment will appreciate or increase in value if the dollar strengthens. On the same lines, if the dollar weakens, your investment may lose its value.
Forex investments can have a big impact on your investment portfolio, regardless of whether you invest in foreign stocks or not. Investors with mutual funds and foreign stock investments would get most affected due to currency fluctuations. Moreover, investors with domestic assets may also see the indirect impact of the price volatility.
The value of your investments may rise or fall depending on numerous factors. If you are not sure about investing, seek the advice of a market expert. Happy investing!