Analyse how exchange rate changes affect the risk and return of a portfolio

The domestic-currency return is RDC = (1 + RFC) × (1 + RFX) − 1, where RFC is the local return and RFX the change in the foreign currency's value against the base currency. A 5% local return with a 3% currency gain gives 8.15%, not 8%. For several currencies, weight each asset's RDC. Risk is roughly σ²(RDC) ≈ σ²(RFC) + σ²(RFX) + 2 × ρ × σ(RFC) × σ(RFX), so currency adds risk unless its correlation with local returns is negative enough to outweigh its own variance. For low-volatility foreign bonds currency risk tends to dominate, so bond portfolios are often hedged. For equities it can partly diversify. Traps: reading the quote the wrong way round and dropping the cross-product or correlation term.