currency

[derswap07]

[question removed by moderator]
I do not understand A and B. Can somone help me with an explanation? Thanks

 

[cpk123]

(1+rfc) * σ(RFX) ==> 1.04 * 8% = σ(RDC) for Australia
also 1.06 * 10% = σ(RDC) for NZ

 

[S2000magician]

The answer to A comes from the fact that for a constant k,
σ(kX) = k × σ(X)
Here, the constant is (1 + r), where r is the return on the (risk-free) bond, and σ(X) is the volatility of the currency returns.
The answer to B is just the formula for the variance of a portfolio’s returns that you learned in Level I.

 

[derswap07]

But what I do not understand is that (1+rfc) * σ(RFX)- why retrun on FC is multiplied by std of fx. I know that ( 1+ Rlc)(1+app/dep in fx) but this one gets me.

 

[MrSmart]

Your standard deviation for the foreign currency will grow by that amount in the future, which is the 1+rfr

 

[S2000magician]

The returns in local currency aren’t volatile, but the exchange rate is.
The volatility of returns in domestic currency increase as the value in local currency increases (a standard deviation of 5% on $100 is greater than the standard deviation of 5% on $90).
The volatility of returns in domestic currency is the volatility of the exchange rate multiplied by (1 + rFC).
Note that if the returns in the foreign currency are also volatile (i.e., you’re not invested in a risk-free asset), then the volatility of returns in the domestic currency has to combine that volatility with the exchange rate volatility; because the rates are multiplied, that computation is very complex (and beyond the scope of the curriculum).