01/08/2001

A New Framework for Currency Strategy - The Fusion of Fundamental Analysis and Financial Engineering

Fumio Nakakubo 

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Introduction

Amid the dismal domestic environment for asset management - including the lowest interest rates onrecord and a floundering stock market - investment in foreign currency denominated assets withhigher expected returns is becoming an increasingly important alternative. However, since these assetsentail exchange rate risks, risk management plays a critical role in investment performance. In otherwords, the first step in successfully managing foreign assets is to be able to predict exchange ratetrends and control exchange rate risks in an appropriate manner.

To fulfill this need, NLI Research Institute has developed a new analytical approach to foreignexchange that combines the long-term perspective of fundamentals analysis, and the short-term perspectiveof financial engineering based on quantitative analysis. This fusion overcomes the shortcomingsof either method alone by revealing short-term exchange rate movements as well as long-termtrends.

The integrated currency strategy consists of: (1) currency strategies based on fundamentals data with aone to three year perspective, and (2) currency tactics with a one-month to one-year perspective. Webegin with an examination of foreign exchange characteristics, on which the integrated currency strategyis based.

Fumio Nakakubo

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