02 September 2021
The currency market is the largest and most liquid in the world with approximately $6.6 trillion traded a day, up from $5.1 trillion in 2016. What makes the FX markets unusual and unlike other markets are the high proportion of participants such as central banks and companies that trade currency because of necessity, as opposed to speculators, purely motivated by returns. This phenomenon can create market inefficiencies and opportunities to generate returns.
In this topic paper, demonstrate the impact that currency can have from the perspective of a risk provider and a return generator. For a risk provider, careful evaluation of an investor’s exposure to foreign exchange moves in their international portfolio is worthwhile and can help to determine the magnitude of risk introduced into their portfolio and if managing currency would be beneficial. For a return generator, clients would be wise to investigate the return generating potential of currency in order to fully assess whether an allocation, either through currency beta or currency alpha, could enhance the overall risk adjusted returns of their existing portfolio.