Expert: Michael A. Weiss, CFA - 6/10/2007

Question
Dear Michael,
This is not exactly about mutual funds but rather foreign currency. I was wondering if people actually invest in say British Pounds. And if people do invest in this kind of thing,how is it done?
                      Thank you,
                        Sam


Answer
Hi Sam,

Thank you for your question.  I know this is not a mutual fund question, but I would be more than happy to help you.  Yes, people invest in foreign currencies.  First, I should explain that people buy or sell foreign currency generally to either speculate about the future price of a particular currency or to hedge a portfolio position.   You could either buy a foreign currency long with the expectation that the foreign currency will appreciate or you could sell a foreign currency short with the expectation that the currency will fall.  When you buy, you make money when price of currency rises.  When you sell, you make money when the price of the currency falls.  

Let me also explain the hedging strategy.  Here is an example:  Portfolio manager of Mutual Fund ABC has found a terrific British stock to add to Mutual Fund ABC.  All of the company’s fundamentals are fantastic and the manager believes the security will appreciate significantly over the next 12 months.  The only issue is, however, that the fund manager believes that the British pound will depreciate substantially over the next twelve months.  To protect the stock’s potential gains, the manager would hedge this investment by taking a short position (selling) foreign currency.  Of course, it costs money to sell the currency, but this cost may be small in comparison to the gains on the stock.  

As far as buying foreign currency for investing or speculating is concerned, this would generally be achieved by entering into options or futures contracts.  There are plenty of physical or online brokers that offer trading in these securities.  If you want to implement this type of strategy, I would suggest selecting a reputable broker and working with a foreign currency specialist to help you guide you through the process.  Be careful if you attempt to implement these types of strategies.  Options and futures are derivatives and can be riskier than the more traditional trades of stocks or bonds.  

I hope this helps.


Sincerely,

Michael A. Weiss, CFA
The Editor
The Mutual Fund Investor
www.mutualfundinvestor.net