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Your clients may be nervous about dabbling in currencies. Here are four factors to consider before investing.

  1. Interest rate differentials: Investors can take advantage of differences in interest rates between two different countries by simultaneously selling a currency with a relatively low interest rate, and buying one with a higher interest rate.
  2. Capital flow: movement of money between countries, whether through investments, trades or business transactions. That gives you an indication of the supply and demand for different currencies.
  3. Sentiment: Investor attitudes can influence exchange rates. Increased appetite for risk drives demand for cyclical currencies like the euro, or currencies with high interest rates, such as the Australian dollar. Risk aversion motivates people to seek out currencies perceived to be safer, such as the Swiss franc and Japanese yen.
  4. Purchasing power parity: the exchange rate, in theory, should adjust such that a basket of goods in Canada is worth the same as in another country. Unless some of the other three factors are in play, a pricing difference means investment opportunity. Some investors simultaneously buy the cheaper basket and sell the more expensive one; reaping quick profit until prices adjust.

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Originally published on Advisor.ca

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