The impact of currency movement on your investments

4.3

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After reading the last chapter, if you thought that taxes and conversion charges are the only ones that you need to concern yourself with when investing in American stocks, here’s a surprise for you. Currency movements, particularly between the USD-INR pair, also play an extremely important role in your investments. 

And so, it is important to keep a watchful eye out to see how the USD-INR pair moves. This way, you can time your investments to coincide with a currency movement that’s favourable for you. In this chapter of Smart Money, we will be focusing entirely on currency movements and their impact on investments, and what you can do about it. So, let’s get on with this now.

How do currency movements affect your trades and investments?

With investments in the American stock market, you’re effectively investing your money in another country - the U.S.A - where the prevailing currency is the U.S. Dollar. And so, to be able to invest in American stocks, you’re required to convert INR to USD at the exchange rate applicable as on the day of conversion.  

Now, we already know that the USD-INR exchange rate is something that’s constantly fluctuating, almost each minute of every single day. So, depending on how both the currencies are moving on the day of conversion, you can either gain money or lose money. This uncertainty in the currency movements is what many experts term ‘currency risk.’

Let’s simplify things even further. If the currency movement is in your favour at the time of conversion, then you basically stand to gain a little extra. On the other hand, if the currency movement is not in your favour at the time of conversion, you tend to lose a little money. Depending on the amount of currency you’re converting, the currency movements’ impact on investments could either be negligible or substantial.

Now, considering the fact that we’re dealing with the USD-INR pair here, let’s take up a couple of scenarios and explore how it affects your investments.  

What happens when the Indian rupee appreciates against the U.S. Dollar?

When experts say that the INR has appreciated against the U.S. Dollar, what do they actually mean? Let’s find out. 

When the INR gains in value against the USD, the INR is said to have appreciated against the USD. Such a situation effectively leads to the dollar getting cheaper. So, it lowers the USD-INR currency exchange rate. And being an Indian investor, it means that you wouldn’t spend as much INR to purchase 1 USD. Conversely, it also means that you would not receive as much INR in exchange for one USD.  

Here’s an example of the INR appreciating against the USD. 

  • Assume that the currency exchange rate of the USD-INR pair is currently at Rs. 72.
  • Now, in this situation, if you had to purchase 1 USD, you would have to pay Rs. 72. 
  • And on the next day, say the INR strengthens considerably and gains in value. 
  • This lowers the currency exchange rate of the USD-INR pair to Rs. 70. 
  • So, if you had to purchase 1 USD on the next day, you would only have to pay Rs. 70 instead of Rs. 72.

This is the kind of a situation that experts refer to when they say that the INR appreciated against the USD.  

INR appreciation and its impact on investments: An example

Now that you have a fair idea of what happens when the INR appreciates, let’s take a look at how this can affect your U.S. stock investments. For the sake of this example, we’ll be disregarding conversion charges and all other fees involved to make understanding easier.

Let’s say that you wish to purchase a share of Tesla Inc. on March 01, 2021 for $700. 

  • The currency exchange rate at the time of purchase is Rs. 72.60. 
  • Now, to purchase 1 share of Tesla, you would need to have $700 in your trading account. 
  • And so, you set out to convert INR to USD. 
  • To purchase $700 USD, you would have to put up around Rs. 50,820 ($700 x Rs. 72.60), going by the current exchange rate. 

On the next day itself, say the stock of Tesla rises up to $720. And so, you decide to cash in on your profits. However, by this time, let’s say the INR has appreciated against the USD.

  • The new USD-INR exchange rate is now Rs. 71.30. 
  • To convert USD back to INR, you would have to do so under the new exchange rate of Rs. 71.30.
  • This means that for every USD that you sell, you would receive only Rs. 71.30 (as opposed to Rs. 72.60 from the previous day). 

So, what is the total amount that you make under this trade? 

In INR, that would be Rs. 51,336 ($720 x Rs. 71.30). 

Although you’ve still made a profit of Rs. 516 (Rs. 51,336 - Rs. 50,820), your actual profits would have been much higher if the INR hadn’t appreciated against the USD.

Here’s how much profit you would have made if the USD-INR exchange rate had remained at Rs. 72.60. 

($720 x Rs. 72.60) - ($700 x Rs. 72.60) = Rs. 52,272 - Rs. 50,820 = Rs. 1,452

Owing to the currency movements between the USD-INR pair, you’ve effectively lost almost Rs. 936 (Rs. 1,452 - Rs. 516).  

What happens when the Indian rupee depreciates against the U.S. Dollar?

Now, when the INR loses its value against the USD, the INR is said to have depreciated against the USD. This would effectively lead to the increase of the USD-INR currency exchange rate. And being an Indian investor, it would mean that you would need to spend a little more to purchase 1 USD. Alternatively, you would receive more INR for one USD.  

Here’s an example of the INR depreciating against the USD.

  • Say that the currency exchange rate of the USD-INR pair is currently at Rs. 70.
  • Now, in this situation, if you had to purchase 1 USD, you would have to pay Rs. 70. 
  • And on the next day, say the INR depreciates quite a bit and loses its value. 
  • This increases the currency exchange rate of the USD-INR to Rs. 72. 
  • So, if you had to purchase 1 USD tomorrow, you would have to pay Rs. 72 instead of Rs. 70. 

Now, this is the kind of situation that experts refer to when they say that the INR depreciated against the USD.  

INR depreciation and its impact on investments: An example

As with the previous example, here’s a quick look at how this scenario can affect your U.S. stock investments. For the sake of this example, we’ll again be disregarding conversion charges and all other fees involved.

Let’s say that you wish to purchase a share of Alphabet Inc. on March 01, 2021 for $2,060.

  • The currency exchange rate at the time of purchase is Rs. 70.54. 
  • Now, to purchase 1 share of Alphabet, you would need to have $2,060 in your trading account. 
  • And so, you set out to convert INR to USD. 
  • To purchase $2,060 USD, you would have to put up around Rs. 1,45,312 ($2,060 x Rs. 70.54), going by the current exchange rate. 

On the very next day, the stock of Alphabet Inc. rises up to $2,075. So, you decide to cash in on your profits. However, by this time the INR had depreciated against the USD.

  • The new USD-INR exchange rate is now Rs. 72.15. 
  • To convert USD back to INR, you would have to do so under this new exchange rate.
  • This means that for every USD that you sell, you would now receive Rs. 72.15 (as opposed to Rs. 70.54 from the previous day). 

So, what is the total amount that you make under this trade? 

In INR, that comes up to Rs. 1,49,711 ($2,075 x Rs. 72.15). 

So, you’ve made a good profit of Rs. 4,399 (Rs. 1,49,711 - Rs. 1,45,312). If the INR hadn’t depreciated against the USD, your actual profits would have been far lower. 

Here’s how much profit you would have made if the USD-INR exchange rate had remained at Rs. 70.54.

($2,075 x Rs. 70.54) - ($2,060 x Rs. 70.54) = Rs. 1,46,370 - Rs. 1,45,312 = Rs. 1,058

You’ve effectively gained almost Rs. 3,341 (Rs. 4,399 - Rs. 1,058), thanks to the INR depreciating against the USD.   

The key takeaway

So, the key takeaway with regard to the impact of currency movement on investments for an Indian investor is that your gains get amplified when the Indian rupee depreciates. And conversely, your gains are reduced when the Indian rupee appreciates. 

That said, there are some things that you can do to reduce the impact of currency movements. For one thing, you could delay the inward remittance of the profits that you make in USD till the time the INR depreciates against the USD. Similarly, you could take advantage of INR appreciation by making outward remittances in USD in bulk to your overseas trading account when the exchange rate is favourable to you. This way, you can reduce the currency risk to a certain extent.   

Wrapping up

That’s about it for this chapter of Smart Money. In the next one, we’ll be focusing on other major factors that you need to be aware of and consider when investing in American stocks. Till then, stay tuned and keep learning!  

A quick recap

  • Currency movements, particularly between the USD-INR pair, play an extremely important role in your investments in American stocks. 
  • The USD-INR exchange rate is something that’s constantly fluctuating, almost each minute of every single day. 
  • Depending on how both the currencies are moving on the day of conversion, you can either gain money or lose money. This uncertainty in the currency movements is what many experts term ‘currency risk.’ 
  • Your gains get amplified when the Indian rupee depreciates. And conversely, your gains are reduced when the Indian rupee appreciates.
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