Exchange rates, related derivative securities and international asset allocation are key elements to consider when making a financial decision in the international market. The foreign exchange (FX) rate is an important consideration in managing a portfolio as it impacts not only the value of investments denominated in different currencies but also their relative performance level when compared with assets located domestically. FX derivatives can be used to hedge against fluctuations in these rates, while asset allocations across countries provide additional diversification benefits and reduce risk. In this essay, I will discuss how these aspects are interrelated and how they can be used to generate returns within a global portfolio.
The exchange rate between two different currencies is determined by market forces such as supply and demand for those respective currencies. This rate is always changing due to influencing factors such as inflationary pressures or geopolitical events (Kemzura & Markauskaite, 2020). Keeping track of movement in this rate helps investors determine whether it would be beneficial to convert into another currency or remain invested locally. For instance, if an investor is holding US dollars but believes that the Euro will appreciate over time then they may move some of their funds into Euros at a favourable exchange rate before prices rise accordingly (Lewis-Barned & Wilkie, 2018). Asset managers must pay attention to movements in FX rates because it affects the overall return of their portfolios; even if all other variables remain constant changes in exchange rates can have a major impact on returns (Yates et al., 2019).
Assess currency exchange rates, related derivative securities and international asset allocation.
In addition, there are various derivative securities based upon currencies which enable investors to obtain exposure without actually converting money into another currency; instead they purchase contracts which track the underlying FX pair at a fixed price on expiry date (Shahmoradi et al., 2016). These products allow for hedging strategies against losses caused by volatility or unexpected movements in FX markets that could otherwise jeopardise gains made through investments elsewhere (Uosofvand et al., 2017). Furthermore, these derivatives offer opportunities for speculation where investors take positions expecting specific outcomes from movements in exchange rates. Regardless of strategy employed however, investing while taking advantage of foreign currency involves taking on risks motivated both by macroeconomic factors as well as micro issues related to specific companies or industries operating abroad (Yates et al., 2019 ).
International asset allocation also plays an important role in generating returns within cross-border portfolios; diversifying across multiple countries reduces any single country risk while still taking advantage of positive developments occurring elsewhere by identifying uncorrelated relationships between assets worldwide. This allows greater flexibility when constructing different types of portfolios depending upon individual goals such as maximising liquidity or increasing overall yield potential regardless of location ‒ allocating funds away from domestic markets towards others with higher growth prospects increases investment opportunities available(Pearce & Seoane-Vazquez ,2016). Additionally services like ETFs facilitate implementing international portfolios quickly and cost effectively ‒ often reducing transaction costs associated with purchasing individual stocks as these products contain groups comprising many equities listed inthe same sector globally(Dutta & Kneer ,2018 ).
Overall looking at both short term fluctuations and long term trends when considering currency exchange rates alongside investing through derivative securities provides effective hedging strategies while further insight gained via international asset allocation allows identification offoreign investments with potentially high yields thus improving chancesof success within global financial markets .