How to Cash In (or Not) on Currency Exposure

A globe-trotting portfolio could have an impact on your bottom line

Esther Pak 21 November, 2012 | 6:00AM

International travellers know that when they go abroad, they will have to exchange pound sterling for other currencies before they can hop in a taxi or pay cash at a restaurant. The same holds true for buying stocks on a foreign exchange, or doing so indirectly via a foreign fund or exchange-traded fund. Before UK investors can buy shares of a foreign stock, they must first trade in their pounds for the foreign currency in which the security is denominated. And when they sell the stock, they'll receive the proceeds in the foreign currency, which they must then exchange for pounds. Appreciation or depreciation in that foreign currency over the time they've held the stock might affect returns--sometimes for the better, sometimes for the worse.

How Do Currency Fluctuations Work?
The value of one currency relative to another can fluctuate for a variety of reasons--the interplay between the countries' trade balances, fiscal and monetary policies, rates of economic growth, and inflation, to name some of the key ones. Foreign currency exposure can be beneficial as part of a well-diversified portfolio because it adds another layer of diversification, much like being diversified across stocks of different sizes and styles.

At the same time, exposure to foreign currencies can also affect a portfolio's performance, sometimes on the upside and sometimes on the downside, particularly during shorter periods of time.

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The information contained within is for educational and informational purposes ONLY. It is not intended nor should it be considered an invitation or inducement to buy or sell a security or securities noted within nor should it be viewed as a communication intended to persuade or incite you to buy or sell security or securities noted within. Any commentary provided is the opinion of the author and should not be considered a personalised recommendation. The information contained within should not be a person's sole basis for making an investment decision. Please contact your financial professional before making an investment decision.

About Author

Esther Pak  is an assistant site editor of Morningstar.com.

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