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Foreign Currency

After my last post on Investing for Beginners I had a few people show interest in the topic and quickly realised a simple paragraph won't do it. So I've decided to create a new blog post where I dive deeper into the topic along with a YouTube video where I go over a presentation with real life examples. So let's get to it :)

Pound vs Dollar in 2020

First, let's look at the currency movement during 2020. We can observe in the graph here how the pound lost value against the US dollar in March when the pandemic started.

Since then, it has slowly regained it's value to pre-pandemic times. Although we can see new adverse volatility in October due to current trade negotiations taking place related to Brexit.

Share Price Movement

The company we are analysing for the purpose of this example is Microsoft, which is listed on the NASDAQ in the US.

As we can see a similar trend to that of the GBP:USD mentioned above where there was a significant loss in value in March due to the pandemic.

The difference here is that the stock did not only come back to pre-pandemic levels but it actually over performed. I believe one of the main drivers was that more people were working from home therefore using applications such as "Teams", the MSFT version of zoom.

Understanding the impact of FX on your investments

In order to understand the impact of both movements on your investment, let's look at the above table. Here we should focus on the "GBP" column as our main focal point, given that this is what will reflect the value of your portfolio.

  • The 1st row represents the value at which the stock was purchased, for illustration purposes we will say $150 per share of MSFT and 1,15 GBP:USD.

  • The 2nd row focuses on just the FX movement, assuming the value of the share price stays flat and therefore seeing the impact of just the FX on your investment. The increase of the FX has a negative impact of your investment. This is because the pound has gained strength over the USD (this of course also means the dollar has become weaker against the pound) and as your investment is originally in USD, the same amount of $150 is now worth less GBP (from 130,43 pounds to 111,94 pounds).

  • The 3rd row looks at the impact of the share price movement on the value of your investment. This is directly correlated, if the USD value increased by 53%, then the GBP value will increase by 53%

  • Finally the 4th row combines the 2 catalysts showing that the increase in share price of 53% has been offset by the negative impact of -14% caused by the strengthening of the pounds (or weakening of the dollar). Therefore leaving the value of your portfolio with a net 32% increase when comparing September to March.

I hope this has helped you have a better understanding. I have also uploaded a brief 5mins video on YouTube which could help you consolidate this knowledge even quicker.

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