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Have you heard of this currency index? - Views on News from Equitymaster
 
 
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  • Jul 7, 2012

    Have you heard of this currency index?

    An index is a compilation of any asset class like stock, bond or a currency. It is basically a proxy to the market. For instance, the 30 stocks in the BSE-Sensex are a proxy to the stock market's performance in general. The same way, a US dollar index is an index that measures the performance of US dollar relative to a basket of currencies. The basket includes currencies like Euro, Yen, Pound, Canadian Dollar, Swedish Krona and Swiss Franc. Each currency is assigned a weight with Euro commanding the highest weight.

    Now having known what the dollar index is, let us turn our focus on how to interpret its movement. Later on we will also see what the movement actually means for the Indian stock markets.

    Like any another index, the dollar index has a base value of 100. An increase in its value means that the US dollar is appreciating against the basket currencies. On the other hand, a decline in value means that the US dollar is depreciating against the currency basket. It may be noted that, since inception, the US dollar index has traded at a high of 148 and low of 71 (Source: Wikipedia).

    But what actually governs the movement of the dollar index?

    Like any other commodity the currency values are determined by the demand supply economics. Positive economic data from US like increase in home sales or expansion in manufacturing activity may suggest that economic revival is on the cards. This by definition should increase the faith in the US economy and lead to appreciation in the dollar index. The reverse is also true.

    Now, let us see how the movement in the dollar index actually affects the Indian stock markets in general. We start by assuming a case of appreciation in the index.

    Appreciation in the dollar index means that the currency basket is depreciating. This effectively means that the rupee is also depreciating. Although rupee is not a part of the currency basket an appreciating dollar against the six major currencies means rupee has also lost value. A depreciating rupee widens the current account deficit by making imports expensive. However, export oriented sectors like IT would benefit from the same. Also, rupee depreciation attracts FII and FDI flows as investing in India turns cheap for foreign investors. Depreciation in the dollar index, however, has the opposite effect. Export driven sectors get hurt and imports become inexpensive. Investing in India turns expensive for foreigners.

      Jinesh Joshi (Research Analyst) holds a masters degree in Finance and has over 8 years of experience in tracking equities. He has a keen affinity for number-crunching and is often sought after for his valuable insights on financial modeling and valuations. He has a keen eye for spotting emerging growth opportunities across sectors and market caps. Jinesh contributes to our Megatrend investing service The India Letter.

     

     

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