sensitivity to changes in an exchange rate

(Sample question 1)

sensitivity to changes in an exchange rate

	Case 1	Case 2
DC (vs. LC)	+10%	-10%(*)
LC (vs. DC)	-10%	+10%
Local stock in LC (exporter)	+6%	-6%
γLC	-0.60	-0.60
Local stock in DC	-4%	+4%(**)

Sensitivity of the stock returns in DC terms to changes in the value of the LC:
γ=γ_LC+1=-0.60+1=0.40

(**) For Case 2,
Total Return of local stock (DC) = +10% - 6% = 4% (10%*0.40)

DC: Domestic Currency
LC: (Foreign country's) Local Currency

(*) An investor in DC gains +10% in DC from FX due to appreciation of LC (depreciation of DC).

---

(Sample question 2)
Sensitivity of the Canadian company A to changes in the GBP/CAD exchange rate = 1.4
= γ(GBP) = γ = γ(CAD) + 1

γ(CAD) = 0.4

This means that the CAD value of the Canadian company A changed by 40% of the amount of the currency change. Hence, if the CAD suddenly depreaciates by 10%, the CAD value of the company falls by 4%.
Canadian stock's total return (GBP)
= -14% = -10% - 4% = Currency return (CAD → GBP) + Local stock return


γ: sensitivity measure