Calculation of Return for Currency

Timothy Peterson

Currency management is different. Though currency management can be thought of as an exploitable zero-sum game, it is commonly used to hedge risk rather than seek return.

Currency is considered by some as an asset class and by others simply as a transaction vehicle. As an asset class, currency carries with it some diversification benefits and short-term return. But, as purely a transaction vehicle, currency itself has no growth because there is nothing to reinvest into. Over the long-term global aggregate, currency return is zero.

In this chapter we provide a currency primer with emphasis on return calculation. This reading is designed to help a novice performance analyst become familiar with terminology and methodologies associated with currency management and return calculation. We examine several possible approaches to calculating return, including spot-on-spot and spot-on-forward, and conclude as to the appropriateness of each. Ultimately we provide two examples, first one for currency pairs trading and the second for a passive currency overlay.

CURRENCY EXPOSURE

Currency exposure arises from the ownership of securities outside an investor’s home country