Quote:
Originally Posted by :::grimReaper:::
FX is the biggest risk, and I'm not referring to fees. I'm going to assume you're American and you use USD. Let's say you want to buy $100k of XYZ currency that offers 5% overnight interest (ignoring compounding) and XYZ/USD is trading at 0.8000.
You buy $100k/0.80000 = 125k XYZ.
After a year you have 125k XYZ * 1.05 = 131.25k XYZ.
However, if XYZ is trading at or below 1/1.05 * 0.8000 = 0.7619, you're losing money on this trade, because at the end of the day, you have to convert this back to USD.
There are many reasons why XYZ can depreciate, higher expected inflation can be one of them.
I get that there is currency risk, of course. And developing countries may well have more volatile currencies.
I also understand what you're saying, that there are two parties determining the price of an equity, so at worst you're just throwing darts. A bank can set an interest rate wherever they want and you have no idea if it's good value or not if you don't do further research.
I don't understand why the exchange rate wouldn't be like a stock. It seems to be the sort of thing where you have two parties, and if it was improperly priced one direction or the other, it would get fixed pretty quickly by lots of buying or selling of that currency.
Are currencies not priced efficiently? If they are priced efficiently, doesn't it mean a currency is just as likely to increase in the next month/year as it is to decrease?