Consider this Scenario:
A year ago your friend Emma, an investor living in the United States, invested in the equity of a European electronics company. She purchased 100 shares at 26.00€ when the exchange rate was 1.42 EUR/USD ($1.42 for each Euro).
One year later, she sold her 100 shares of the European electronics company equity at a price of 27.50€ per share and the exchange rate is now 1.30 EUR/USD.
What is the one-year return in EUR and USD on Emma’s investment?
For the purpose of this example ignore costs such as trading commissions, other trading costs, custody costs, etc.
Solution:
Return in Euros:
Purchase August 2016: 100 Shares x 26.00 €/share = 2,600 €
Sell August 2017: 100 Shares x 27.50 €/share = 2,750 €
One Year Return = (2,750 € – 2,600 €) / 2,600 € = 5.769%
Return in US Dollars:
Purchase August 2016: 100 Shares x 26.00 € /share x 1.42 EUR/USD = $3,692.00
Sell August 2017: 100 Shares x 27.50 € /share x 1.30 EUR/USD = $3,575.00
One Year Return = ($3,575 - $3,692) / ($3,692) = -3.169%
Emma is an American investor so her return in US dollars was -3.169%. She had a negative return despite the fact that the price of the European equity in Euros increased by 5.769% from when she bought it.
Changes in exchange rates can have a significant impact on returns of foreign investments.
This example illustrates that investing in foreign companies when the corresponding foreign currency depreciates will reduce gains for the foreign investments (in this case taking a positive gain to a negative gain). Emma’s investment was exposed to the equity risk associated with investing in the European electronics company and the foreign currency risk associated with making an investment in a foreign investment.
The financial advisors at WrapManager can provide expert advice on diversifying your portfolio with foreign investments. Give them a call at 1-800-541-7774 or contact us here to get in touch with a Wealth Manager today.
Check out another quiz from Doug's Quiz Corner!
This quiz is intended for informational and illustrative purposes only. This quiz is intended for informational and illustrative purposes only. This material is not intended to be relied on as a forecast, research or investment advice, and is not a recommendation, offer or solicitation to buy or sell any securities or to adopt any investment strategy. The information presented is general information that does not take into account your individual circumstances, financial situation or needs, nor does it present a personalized recommendation to you. The information and opinions contained in this material are derived from sources deemed reliable, are not all-inclusive and are not guaranteed as to accuracy.
The information presented by WrapManager, Inc. is general information only and does not represent tax or legal advice, either expressed or implied. You are encouraged to seek professional tax advice for income tax questions and assistance. WrapManager, Inc. does not advise on any income tax requirements or issues.