Sales Trader
Summary: Investors trading in global equity markets are subjected to a wide variety of risks including company specific risk and market risk. However, a lesser known risk facing investors as they invest in equities denominated in different currencies is FX risk. FX risk affects investors who buy equities in a different currency from their base currency (currency of their home country or where most of their income is based in) and this can impact their equity returns over time.
What happens to your stock returns when USDSGD moves?
Suppose you bought Microsoft at the market open on 2nd October 2023. On 29th December 2023, your investment in Microsoft has done well with Microsoft gaining 18.89%. As Microsoft is priced in USD, the returns of 18.89% will be in USD terms. However, in SGD terms, the total return will depend very much on how USDSGD moved during the holding period. During this period, USDSGD fell from 1.3728 to 1.3197 which has affected the returns negatively. On the contrary, if USDSGD rose during this period, your returns would have been higher than 18.89%.
In the example above, due to USDSGD falling during the holding period, the overall return of the investment fell from 18.89% to 14.30% in SGD terms. On the contrary, if USDSGD went up, then that would have meant a better return than 18.89%.
What Can Investors Do?
1. Do nothing.
If investors are consciously taking the FX exposure in the stock investment or have a view that USDSGD will go higher for their investment horizon, they can choose to do nothing and let the FX exposure prevail. Their overall return in SGD terms will fluctuate based on the USDSGD rate.
2. Investor can hedge the FX exposure by trading FX spot or FX forward.
Investors can hedge the FX exposure by selling the equivalent of the USD exposure in the Microsoft stock with the following steps below:
a) Calculate the USD exposure of the position. This is 31,628 USD in the example above.
b) Sell 31,628 USDSGD as an FX spot position.
c) P&L from this position is summarized in the table below. In SGD terms, it is $1679.45.
The P&L calculation above is a simplified one ignoring the effect of interest rate differential between USD and SGD which may be favourable or adverse to the investor depending on the prevailing interest rate in USD and SGD. If investors want a precise hedge then they can choose to do an FX forward for their expected duration of the investment upfront and roll it over to a further date when needed.
FX hedging impact on equity return in SGD terms
If we examine the impact of equity returns from FX hedging, we see that this raises the return (%) in SGD terms from 14.30% to 18.16%. It is still a little lower than the original stock returns of 18.89% as the FX hedging is only done at the beginning of the trade. To achieve the exact stock returns in SGD terms, the investor would need to constantly FX hedge as the USD exposure rises as Microsoft heads higher.
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