What you will learn
- Convert foreign-currency exposure into home-currency scenarios.
- Estimate how leverage and margin magnify an exchange-rate move.
Where exchange-rate risk appears
Exchange-rate risk arises whenever value is held in one currency but measured in another. A Hong Kong resident who owns an overseas asset sees the result change as the exchange rate moves, even if the asset's own price does not.
The home-currency return combines two parts. If the asset returns r in its own currency and that currency changes by f against the home currency, the combined return is (1 + r) × (1 + f) - 1: the effects compound rather than add.
Building a scenario table
A scenario table lists several exchange-rate changes, such as -10%, -5%, 0, +5% and +10%, and recalculates the home-currency value for each. It shows sensitivity and does not forecast which row will occur.
Base the range on the pair's historical volatility rather than a hunch, and include at least one uncomfortable row. If the worst row would cause real difficulty, that is worth knowing before the exposure exists.
Leverage and margin
Margin trading lets a small deposit support a much larger exposure. With 5,000 of margin behind 100,000 of exposure, leverage is 20 times, and each 1% exchange-rate move changes equity by 20%.
Providers close positions automatically when equity falls too low, often before the deposit is gone. Losses can therefore be locked in at poor prices, and in a fast gap they may exceed the deposit under some account terms.
Worked example: Home-currency scenarios
A Hong Kong investor holds an asset worth 10,000 units of fictional Currency F, quoted at 8.00 HKD per unit, so its value is 80,000 HKD. If F weakens 5% to 7.60, the value is 76,000 HKD. If the asset also falls 10% in F, the combined result is 0.90 × 0.95 = 0.855, so the holding is worth 68,400 HKD, a 14.5% loss.
Check your understanding
A leveraged currency position has 100,000 of exposure and 5,000 of margin. How much equity is lost if the exchange rate moves 2% against it, and what move would erase the margin?
Show answer and explanation
A 2% move on 100,000 is 2,000, or 40% of the 5,000 margin. Leverage is 100,000 ÷ 5,000 = 20 times, so a move of 1 ÷ 20 = 5% erases the margin, although automatic closing rules usually act earlier.