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The Equitymaster Research Digest

Currency Projections, Risk in Small Caps, and More...
Dec 4, 2015

We are often asked our views on currencies. Not for the short term but two to three years out. For a lot of companies we track, especially in sectors like IT and pharma, the majority of their revenues are earned in dollar terms. Therefore, it is important to make a call on exchange rates so that an accurate analysis can be done. As more and more Indian companies go international, currency predictions will grow in importance.

This is easier said than done though. Exchange rate predictions are tricky. Stocks have cash flows associated with them that can be discounted to the present to try to get a sense of the company's intrinsic value. Not the case with currencies.

Indeed, we hold that the very concept of an intrinsic value or the true value of a currency is extremely tenuous. No one can say for sure whether the rupee is undervalued or overvalued at a level of 60 to the dollar.

Therefore, what matters is not the currency's true value but the direction of change. In other words, we should be more concerned about whether the currency will appreciate or depreciate against the reserve currency - and the magnitude of this change. And this is precisely what we attempt to do when we try to forecast exchange rates for our financial models.

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