Understanding Currency Movements and Monetary Policy

Chris Haroun
A free video tutorial from Chris Haroun
Award Winning MBA Professor, Venture Capitalist and Author.
4.4 instructor rating • 51 courses • 832,464 students

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The Complete Financial Analyst Training & Investing Course

Succeed as a Financial Analyst &Investor by Award Winning MBA Prof who worked @Goldman, in Hedge Funds & Venture Capital

22:31:28 of on-demand video • Updated April 2020

  • 22+ hour complete financial analyst course!
  • #1 Best Selling Investing Course on Udemy!
  • How to pick stocks.
  • Become an expert in Excel for financial analysts (no prior Excel knowledge is required).
  • How to manage a portfolio.
  • How an IPO works.
  • How to build financial models.
  • How to get hired and promoted as a financial analyst.
  • How risk management works.
  • How to use technical analysis.
  • How to value companies.
  • Use and create Excel based templates developed by Chris to help you create financial statements from scratch (meaning income statements, balance sheets, cash flow statements and more).
  • Use and create Excel based templates developed by Chris to help you value companies using several different valuation methodologies, including P/E, P/R and Discounted Cash Flow (DCF).
  • Use and create Excel based templates developed by Chris to help you manage a portfolio.
  • How Monetary Policy works.
  • How Fiscal Policy works.
  • How interest rates are changed and why this is crucial to understand for successful financial analysts.
  • How to pitch long and short ideas to portfolio managers.
  • How to find great venture capital investment ideas.
  • How to come up with mutual fund investment ideas (longs - meaning buys) using an easy to understand top down and bottoms up research process.
  • How to come up with hedge fund investment ideas (longs and shorts) using an easy to understand top down and bottoms up research process.
  • Identify crucial catalysts (timed events) in order to know when the optimal time is to buy or short a stock.
  • Understand how investment banks (the 'Sell Side') can help you be more successful in a hedge fund or mutual fund career.
  • Analyze and understand an income statement (even if you have no experience with income statements).
  • Analyze and understand a balance sheet (even if you have no experience with balance sheets).
  • Analyze and understand a cash flow statement (even if you have no experience with cash flow statements).
  • Understand and use modeling best practices so you can create financial models.
  • Know where to get data in order to build a financial model (in depth understanding of identifying and using/navigating the best free websites and sources to build your financial model)!
  • Create a financial model (projecting the future) for an income statement.
  • Other valuation methodologies, including EV/Sales, EV/EBITDA, P/B, EV/FCF, etc.
  • Create a financial model (projecting the future) for a balance sheet.
  • Create a financial model (projecting the future) for a cash flow statement.
  • Understand valuation best practices so you can create target prices based on your financial models.
  • How to use Discounted Cash Flow (DCF) and how to create the Weighted Average Cost of Capital and Terminal values in order to pick target prices.
  • How to use P/E in order to pick target prices.
  • How to use P/R in order to pick target prices.
  • Come up with a target price based on an average of several different valuation methodologies.
  • Learn about 14 different Financial Analyst jobs and how they overlap and work together (including Investment Banking, Venture Capital, Private Equity, Private Wealth Management etc.).
  • Investment Banking: Understand from a high level perspective what an Investment Bank is as well as what the role/job is of an Investment Banking Financial Analyst, including the pros and cons.
  • Venture Capital: Understand from a high level perspective what a Venture Capital firm is as well as what the role/job is of a Venture Capital Financial Analyst, including the pros and cons.
  • Private Equity: Understand from a high level perspective what a Private Equity firm is as well as what the role/job is of a Private Equity Financial Analyst, including the pros and cons.
  • Private Wealth Management: Understand from a high level perspective what a Private Wealth Management firm is as well as what the role/job is of a Private Wealth Management Financial Analyst, including the pros and cons.
  • Sell Side Research Analyst: Understand from a high level perspective what a Sell Side Research Analyst’s firm is as well as what the role/job is of a Sell Side Research Financial Analyst, including the pros and cons.
  • Sales Trader: Understand from a high level perspective what a Sales Trader’s firm is as well as what the role/job is of a Sales Trader Financial Analyst, including the pros and cons.
  • Buy Side Trader: Understand from a high level perspective what a Buy Side Trader’s firm is as well as what the role/job is of a Buy Side Trader Financial Analyst, including the pros and cons.
  • Mutual Fund: Understand from a high level perspective what a Mutual Fund is as well as what the role/job is of a Mutual Fund Financial Analyst, including the pros and cons.
  • Sell Side Trader: Understand from a high level perspective what a Sell Side Trader’s firm is as well as what the role/job is of a Sell Side Trader Financial Analyst, including the pros and cons.
  • Large Non Finance Company: Understand from a high level perspective what a Large Non Finance Company firm is as well as what the role/job is of a Large Non Finance Company Financial Analyst, including the pros and cons.
  • Equity Capital Markets: Understand from a high level perspective what an Equity Capital Markets’ firm is as well as what the role/job is of a Equity Capital Markets Financial Analyst, including the pros and cons.
  • Hedge Fund: Understand from a high level perspective what a Hedge Fund is as well as what the role/job is of a Hedge Fund Financial Analyst, including the pros and cons.
  • Equity Sales: Understand from a high level perspective what an Equity Sales’ firm is as well as what the role/job is of an Equity Sales Financial Analyst, including the pros and cons.
  • Tech / Artificial Intelligence: Understand from a high level perspective what a Tech / Artificial Intelligence’s firm is as well as what the role/job is of a Tech / Artificial Intelligence Financial Analyst, including the pros and cons.
  • Learn what finance role you are most passionate about pursuing.
English -: It's important to note that when stable economies have high interest rates, the value of their currencies goes up a lot relative to other currencies, and we really need to understand this phenomenon when we analyze companies that are doing business in other countries. Unless that company hedges out their currency exposure, meaning that they buy an insurance finance product that protects the currency they're exposed to if it goes down a lot. And we'll cover the concept of making money when stocks go down, meaning shorting securities, later in the course, but what happens is you can actually make money, or protect yourself by buying financial instruments that are profitable if a certain commodity or stock, et cetera goes down a lot. Before I go on, let me quickly talk about Southwest. Southwest is a juggernaut of an airline, a big airline here in the United States. And they put, or almost put, almost all their competitors out of business last decade, and the way they did that was around 2000, 2001, 2002, they bought a ton of forward contracts on the price of oil, a hedge. So if the price of oil went up a lot, they made money, but they set it up in such a way that they are protected if prices were very volatile, and when prices went up materially for the price of oil, when oil was like $100 a barrel, what Southwest did was because they had exposed themself in a hedging way, so that oil only cost them $30 a barrel, they cut prices aggressively and it was very predatory and they almost put some of their competitors into bankruptcy. Again, we'll talk about hedging a little bit later, but I wanted to put that on your dashboard. So let's move on. So generally speaking, the United States dollar strengthens when the US government raises interest rates, or when other countries, see the US as a relative flight to quality in times of extreme economic uncertainty. And a great website for understanding not just currency rates, but inflation levels also is www.xe.com/currency, okay, check that out if you get a chance. And so, if you go to that website, and you click on CAD, or C A D for Canadian dollars, we can see that the inflation rate in Canada is 1.6%, which means prices rise by about 1.6% every single year in Canada. And just above that figure here, we can see the exchange rate for Canadian dollars in other major currencies. And we can see here that one Canadian dollar buys 73 US cents, or one US dollar buys $1.37 Canadian. And we can also see that the nickname for the Canadian dollar is the loonie, as the loon is on our Canadian one dollar coin. Okay let's move on. We also see that the interest rate in Canada, which is called the central bank rate, is 0.5%, very low. And we can also link to the Bank of Canada from this website here, you see it here? Which is the source of the interest rate and inflation statistics here. Okay, let's go back to xe.com's website. And we can see charts of historical moves in currencies here. And if the company that we are investing in does a lot of business in other countries, we really need to know what the currency exchange rates are, or else we might not be able to calculate the correct earnings estimates if the company does not hedge out or cancel the exchange rate differential with financial products. Remember I talked about Southwest hedging out the price of oil. Companies can do the same thing with exchange rates, and again we'll cover hedging later in more detail. Okay so, economies that are more dependent than others on selling commodities, or other natural resources like oil, include Canada, Australia, and Brazil. As such, most of the time, when oil prices are very high, so too are the three currencies relative to other currencies. Why is that the case? Why is it the case that the Canadian dollar, the Australian dollar, and the Brazilian real go up a lot when the price of oil goes up? Well this example explains why. If the price of most major commodities are very high, then if China wants to build a lot of iron ore, or buy a lot I should say from Australia, to make steel, then China would have to buy more Australian dollars in order to buy Australian iron ore, which drives the price of the Australian dollar up. And the same thing can be said if China wants to buy more oil from Canada, Canada has a lot of oil, heavy oil that's only profitable if the price of oil's very high because it's very expensive to extract that. And so in terms of Australia, with iron ore, the converse of course holds true. When most commodity prices are dropping, then when China needs to exchange money to buy those commodities, it can exchange less money for fewer Australian dollars in order to buy Australian commodities. And if China decided all of a sudden, this is not gonna happen, but if they decided to stop construction for a long period of time, then you'd see the price of commodities going down a lot, which would mean the price of the currencies for natural resource rich countries like Australia, Brazil and Canada would go down a lot. And this happened a little bit in 2008. So what China did was they had the Olympics in 2008, and it was an incredible success, it was amazing, but what the Chinese government did was three months before the Beijing Olympics in 2008, the Chinese government shut down all industrial production within a 300 mile or so radius around Beijing so that when the whole world arrived, it would look like there wasn't as much pollution there. And that actually had an impact, that's one of the reasons why there was a bit of a commodity hit that happened in 2008, of course there was other reasons as well, I digress. I also like to look, to use this website for looking at historical exchange rates, it's called www.forexfactory.com, and this website is incredibly detailed. So if we look at the historical charts of the Canadian dollar, relative to the US dollar, we see that the Canadian dollar was at par with the US dollar, meaning that both were valued at $1 each, relative to each other in 2008. Why? Because at that point in 2008, the price of oil was over $100. So far, we have discussed currencies that are what are called floating currencies, meaning currencies that increase or decrease relative to other currencies. Based on supply and demand. Now governments that do a lot of business with one or a few larger countries, what they do is they actually fix or peg their currency to another one. So the value of their currency never changes relative to the larger country's currency. And the way that these countries maintain their fixed or pegged currency is through massive open market purchases, or sales of their own currency. Through that country's reserves of foreign currency. So stick with me here. So when demand is too high for their own currency, these governments will buy bonds, which basically, the government gets bonds, and in return they give others money and what happens is there's more supply of money out there, and so what happens is the rate of their money, the FX rate, goes down, or stays fixed to that economy that they wanna have their currency rate fixed at. Now the only way that you can maintain your currency fixed at a price that's relative to another currency, is if you have a lot of reserves, a big stock pile of money, so you can buy and sell. Recall that the higher the supply of a currency, the lower the interest rate is for that currency. This is artificial, and it can be manipulated for many, many years by countries, as long as their underlying currency reserves are plentiful. I know what you're thinkin' now. What happens if they run out? Well I'm gonna talk about, this is controversial, and a lot of people won't appreciate me bringing this up, but I have to. George Soros, he's the most successful currency or macro trader in history, and he's made billions of dollars by breaking country's currencies, which can have a traumatic impact. So he's made billions of dollars, including a billion dollars in one day by forcing governments to make their fixed or pegged currency change to float it. He forced them to do it. How'd he do it? Well he did this to the Bank of England, and he also did this to the Thai baht. And how did he break the Bank of England and the Bank of Thailand? How did he force them to get rid of their fixed exchange rate and make it variable, and make it float? And what he did was he bet against those currencies, so when the governments were forced to float them, the currencies dropped a lot and he made a fortune, and that's called shorting. Again we'll talk about that in more detail later, but I wanted to kind of put it on your radar screen a little bit more so now. So in terms of the Thai baht, in the mid to late 1990s, there was this awful asian crisis that people called the asian flu at the time, and people speculate that Soros helped make it much worse. And so the economy in Thailand then was not doing that well, and the government in Thailand wanted to maintain their fixed currency status. And demand for the Thai baht was down a bunch, because of the crisis in Asia, the crisis that asian countries had at that time. So in order to maintain the current fixed exchange rate, the government of Thailand purchased a lot of their own currency, the Thai baht with US dollars. Therefore, artificially keeping demand high for the Thai baht, which kept the exchange rate of the Thai baht fixed to the US dollar. Since there were fewer bahts out there from a supply perspective, the government of Thailand was able to keep the fixed value of the baht at a fixed price relative to the US dollar. And so at that point, the government of Thailand had about $37 billion in US dollar reserves, so that they could keep that fixed rate. Soros pressed his short bet on the Thai baht and other hedge funds joined him, the smelled blood in the water. It happens, they all, they called it the hedge fund mafia, they all jump on it together. This happens to a lot of stocks too, they get shorted. It's tragic. This assault or drive by assault occurred, more hedge funds jumped on it, they sensed blood in the water, including a very famous hedge fund called Tiger that had a $3 billion bet against the baht. And eventually the government of Thailand ran out of their US dollar foreign reserves and they couldn't prop up the baht relative to the US dollar. And so they had to let the free market take over and float the Thai baht. And Soros, George Soros and other hedge funds made an absolute fortune offshoring the Thai baht, which went down a lot after the government ran out of foreign reserves, and had to let the Thai baht float, which meant it went down a lot. And George Soros did the same thing kind of with the Bank of England, and he made a lot of profit in 1992 on what traders call Black Wednesday. Although he broke the British pound currency peg, he did far less damage to the British economy than he did to economies in southeast Asia in general. And so at that time though, in 1992, the British pound was pegged to the German Deutsche mark. In the early 1990s, Germany had to raise interest rates a bunch in order to keep inflation low, and they had growing pains as well because of the unification of East and West Germany. And also at that time, the US economy was not doing that well, which really hurt the UK, as the UK did a lot of business with the United States as a trading partner. And so the British government ran out of reserves and George Soros' massive short position caused the Bank of England to let the pound float. George Soros made a billion dollars that day as the pound dropped about 10% that day and Soros profited from his short position in the pound. And so we know that shorting an investment basically means that you make money if it goes down, so it's basically the opposite of buying a stock or buying an investment. And so the following countries have their currencies pegged to the US dollar, or other relatively stable and strong economies. As these countries might do a lot of business with the United States, or these other countries, and hence rather than dealing with the uncertainty with FX, or foreign exchange swings, these currencies remain fixed at the same level, or same price to the United States dollar, or the other currencies, until someone like a George Soros might potentially one day force them to change this policy. So we know that high inflation leads to higher interest rates, and I think it's really important to discuss great economic entities or events that are somewhat deflationary. You really have to look for long term economic trends. So I'll give you a couple of examples, Walmart had a big impact on deflation in the United States. Prices were kept in check because Walmart, they offered everything, sold everything for next to nothing. And the same thing can be said for Amazon now. I think Amazon actually is keeping inflation in check in America right now, and in many countries too. And Amazon has something called Amazon web services, which basically is the software infrastructure that every massive, high growing internet company runs on now. So for the most part, like Uber for example, and Netflix, and Airbnb, they run off the Amazon web services, and Amazon keeps cutting that pricing point a lot. And so, when I think of Amazon web services today, I think it's incredibly deflationary, to the same extent that the Berlin wall was back in the late 80s, early 90s, when Reagan had that epic speech, I'm getting shivers just thinking of it, when he said, "Mister Gorbachev, tear down that wall." What happened was you had all this brilliant Eastern European cheaper labor move west, and the biggest input price into producing most products is labor. And so the price of labor stayed low for a while and that's why we had unprecedented economic growth back in the 1990s.