The return on a foreign investment has two components: the change in its local price and the change in the currency used to translate that value back into the money you spend.
Start by choosing that reference currency. A U.S. investor saving for dollar expenses and a European investor saving for euro expenses can experience different returns from the same asset.
How the returns combine
Suppose you exchange $11,000 for €10,000 at $1.10 per euro and invest it. The investment rises 8% to €10,800, but the euro falls 5% against the dollar, to $1.045. Your position is now worth $11,286, a dollar gain of 2.6%.
The calculation is (1 + local return) × (1 + currency return) − 1. Here, 1.08 × 0.95 − 1 = 2.6%. Simply adding 8% and −5% gives 3%, which misses the interaction between the two changes.
Currency can also cushion an investment loss. The important point is to identify it as a separate exposure, rather than attribute the entire result to stock selection.
The direction of the currency quote
EUR/USD at 1.10 means one euro buys $1.10. USD/JPY at 150 means one dollar buys ¥150. A rise in the first quote means a stronger euro; a rise in the second means a weaker yen relative to the dollar.
A ¥1.5 million holding is worth $10,000 at USD/JPY 150. At 155, with the yen value unchanged, it is worth about $9,677.42. Dividing by the quote is essential. CME's guide to spot and futures FX prices explains why different quote conventions can make apparently similar currency prices look different.
Trading currency is not always economic exposure
An investment listed and traded in dollars can still own foreign assets. Paying dollars for the wrapper does not automatically hedge the underlying currency. Conversely, a company listed abroad may earn much of its revenue in dollars, so its business exposure need not match its listing currency.
Separate three things: the currency in which you place the order, the currencies affecting the investment's economics, and any hedge the product actually maintains. A fund described as currency-hedged should explain its method, coverage, and residual exposure in its documents.
A hedge offsets an identified amount
Imagine holding €10,000 in cash at $1.10 and entering a hypothetical linear short exposure to €10,000 at that same reference. If the euro falls to $1.05, the cash loses $500 in dollar value and the short gains $500 before costs.
That clean example assumes the same amount and reference throughout. If the investment grows to €10,800 while the hedge remains €10,000, €800 is unhedged. If instead you owe euros for a future expense, the direction reverses: a rising euro increases your dollar cost, so protection would involve buying euro exposure.
Forward prices include financing
A forward exchange rate is not simply the market's forecast of the future spot rate. It also reflects the interest available in each currency. Otherwise a trader could borrow in one currency, invest in the other, and lock an inconsistent conversion rate.
In a simplified one-year example, let spot be $1.10 per euro, the dollar rate 5%, and the euro rate 3%. Ignoring credit, collateral, and market frictions, the corresponding forward rate is 1.10 × 1.05 / 1.03, or about $1.12136 per euro. CME's discussion of FX cost of carry explains this interest-rate relationship. It does not imply the euro is expected to appreciate by that amount.
A payment or a changing portfolio
For a known foreign-currency payment, the amount and date may be clear. For a changing investment portfolio, both are uncertain, so maintaining the hedge involves adjustment and cost.
Evaluate the result in the currency of the eventual spending need, including conversion spreads, financing, and any margin requirement. A hedge that stabilizes a future euro payment in dollars serves that dollar spending plan. It need not produce the most stable result for an investor measuring wealth in euros.