Portfolio Design: A Modern Approach to Asset Allocation

CURRENCY CAPITAL GAINS AND FOREIGN STOCK RETURNS

The returns reported in Table 5.2 and the accompanying figures are all measured in U.S. dollars in order to make them comparable to one another. Foreign stocks are denominated in their local currencies, but it’s the return measured in dollars that matters to American investors. The return in dollars reflects both the return in local currency and the capital gain on the foreign currency.

Let RL be the return on foreign stocks in local currency and RX the capital gain on the foreign currency (measured in dollars per foreign currency). Then the return on foreign stocks measured in dollars, R$, is obtained as follows:

In 2003, for example, the return on Japanese stocks was 23.0 percent measured in yen, but the yen appreciated by 10.7 percent. So the return on Japanese stocks measured in dollars for the American investor was 36.2 percent:

The Japanese investor received the 23.0 percent return measured in yen, while the American investor received the higher 36.2 percent return that reflects the capital gain on the yen in 2003.

Figure 5.4 shows the average compound returns on foreign stocks measured in local currency and in dollars. In the case of the EAFE index as a whole, for example, the return in local currency from 1970 to 2009 was only ...