Empirical Study on Five Major Currency Pairs (February 2010

Optimal Portfolio Based on Hourly Trading in Foreign Exchange:
Empirical Study on Five Major Currency Pairs
(February 2010 – April 2010)
By:
Martin Ariane Wibisana
19007009
Undergraduate Program
School of Business and Management
Institut Teknologi Bandung
2010
APPROVAL PAGE
Optimal Portfolio Based on Hourly Trading in Foreign Exchange:
Empirical Study on Five Major Currency Pairs
(February 2010 – April 2010)
By
Martin Ariane Wibisana
19007009
A Final Project in Partial Fulfillment
of the Requirement for the Degree of Bachelor of Management
Undergraduate Program of Management Study
School of Business and Management
Institut Teknologi Bandung
August 26, 2010
Approved By
____________________________
Ir. Achmad Herlanto Anggono, MBA
NIP: 999 089 103
ABSTRACT
The investment world is full of uncertainty. Volatility of the asset is such a double-sided
sword for every investor. In one side, investor could make a huge profit by utilizing the
volatility; in other side they could loss of money because of it.
Foreign exchange (forex) market has become one of the most popular investment
instruments because of its volatility. This market has the highest volatility compared to
another market. With this condition of market, the forex investors are accused to be
observant in seeing opportunities by utilizing the market volatility. They have to be able
to manage the risk effectively without losing any profit.
This paper will try to find the way to manage the risk and return in hourly forex trading
by using Markowitz modern portfolio and value at risk (VaR) as a consideration of the
risk limitation of the portfolio and evaluate whether the portfolio is efficient enough
according to the comparison of its return to its risk.
The object of this research is the five most traded exchange currency pairs, which are
Australian Dollar/US Dollar (AUD/USD), Euro/US Dollar (EUR/USD), Great Britain
Pound Sterling/US Dollar (GBP), Swiss Franc/US Dollar (CHF/USD), and Japanese
Yen/US Dollar (JPY/USD). The hourly price data of these currency pairs are obtained
during the three months of internship period (February 2010 – April 2010) in Valbury
Asia Futures.
Key words: forex, currency, forex portfolio, value at risk
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ABSTRAK
Dunia investas adalah duniai yang penuh dengan ketidakpastian. Volatilitas dari sebuah
perubahan nilai asset dalam dunia investasi seperti pedang bermata dua untuk setiap
investor. Di satu sisi, investor bisa membuat keuntungan besar dengan memanfaatkan
volatilitas; di sisi lain mereka bisa kehilangan banyak karenanya.
Valuta asing (forex) pasar telah menjadi salah satu instrumen investasi yang paling
populer karena volatilitasnya. Pasar ini memiliki volatilitas tertinggi dibandingkan pasar
lain. Dengan kondisi pasar seperti ini, para investor forex yang dituduh harus jeli dalam
melihat peluang dengan memanfaatkan volatilitas pasar. Mereka harus mampu
mengelola
risiko
secara
efektif
tanpa
kehilangan
keuntungan.
Makalah ini akan mencoba untuk menemukan jalan untuk mengelola risiko dan
keuntungan dalam trading forex harian per jam dengan menggunakan metode portofolio
Markowitz modern dan Value at Risk (VaR) sebagai pertimbangan keterbatasan
portofolio risiko dan mengevaluasi apakah portofolio tersebut cukup efisien menurut
perbandingan antara risiko terburuk dari investasi tersebut terhadap tingkat
pengembalian.
Objek penelitian ini adalah lima pasangan mata uang yang paling diperdagangkan tukar,
yang Dolar Australia / US Dollar (AUD / USD), Euro / US Dollar (EUR / USD), Great
Britain Pound Sterling / US Dollar (GBP), Swiss Franc / US Dollar (USD / CHF), dan
Yen Jepang / US Dollar (JPY / USD). Data harga per jam dari pasangan mata uang
diperoleh selama periode tiga bulan magang (Februari 2010 - April 2010) di Valbury
Asia Futures.
Kata kunci: pasar uang, pertukaran mata uang asing, risiko
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FOREWORD
“The significant problems we face in life cannot be solved at the same level of thinking we were
at when we created them” - Albert Einstein.
The quote above could be a reason why we have to learn every day. Every single day is about
how to learn from the problem we face. Every lesson we have learned should bring us to a better
way of thinking and behaving. With the better way of thinking and behaving we will be known
how to live our life better.
Study in SBM-ITB is one of the important learning stages in my life. SBM-ITB is the place
where we learn about the meaning of teamwork, perseverance, happiness, disappointment, and so
many things that has brought the colors in my journey to be a better person.
Finally, after precious three years, I have arrived to the end of this one important learning stage.
This final project is one of the requirements to be fulfilled to finish my S1 study in SBM-ITB.
Alhamdulillah, it has been finished well. For that, I would like to say thank you to some parties
that have been contributed to this final project completion:
1. The most merciful and the most graceful, ALLAH SWT. Praise the lord for all of the blessings
and mercies,
2. Mr. Ir. Achmad Herlanto Anggono, MBA for all of the guidance during the completion of this
final project.
3. My parents who always give our prayers, love, advices, affection, and enthusiasm every time.
4. Mr. Achmad Danu Prasetyo, S.T., MSM for the precious advices and guidance.
5. All of the SBM-ITB staffs, Mrs. Ikum, Mrs. Wiwid, Mr. Muji, and others that I could not tell
one by one. Thank you for all of the meaningful helps and services.
May the blessings of Allah will always be with you all.
Finally, I hope this project can be useful for the reader, especially for my junior in SBM-ITB.
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LIST OF CONTENTS
ABSTRACT .......................................................................................................................... ii
ABSTRAK ............................................................................................................................ iii
FOREWORD ........................................................................................................................ iv
LIST OF CONTENTS .......................................................................................................... v
LIST OF TABLES ................................................................................................................ vii
LIST OF APPENDICES ....................................................................................................... viii
CHAPTER I – INTRODUCTION ........................................................................................ 1
1.1
Background ............................................................................................................... 1
1.2
Problem Identification ............................................................................................... 4
1.3
Objective ................................................................................................................... 4
1.4
Problem Limitation ................................................................................................... 4
CHAPTER II – LITERATURE REVIEW ............................................................................ 5
2.1
General Knowledge About Foreign Exchange .......................................................... 5
2.2
Rate of Return ........................................................................................................... 6
2.3
Expected Return ........................................................................................................ 7
2.4
Variance & Volatility ................................................................................................ 7
2.5
Portfolio ..................................................................................................................... 8
2.6
2.5.1
Portfolio Expected Return .......................................................................... 9
2.5.2
Portfolio Risk ............................................................................................. 9
2.5.3
Optimal Portfolio Using Efficient Frontier ................................................. 11
Value at Risk ............................................................................................................. 12
CHAPTER III – METHODOLOGY..................................................................................... 13
3.1
Problem Identification ............................................................................................... 13
3.2
Research Objective .................................................................................................... 14
3.3
Literature Study and Data Collection ........................................................................ 14
3.4
Data Analysis………………………………………………………………….…… 14
3.5
Conclusion & Recommendation………………………………………………….... 14
CHAPTER IV – DATA ANALYSIS.................................................................................... 15
4.1
Expected Return ........................................................................................................ 15
4.2
Volatility.................................................................................................................... 15
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4.3
Variance – Covariance Table………………………………………………………. 15
4.4
Correlation Table…………………………………………………………………... 16
4.5
Efficient Frontier…………………………………………………………………. .. 16
4.6
Portfolio Value at Risk .............................................................................................. 19
CHAPTER V – CONCLUSION AND RECOMMENDATION .......................................... 21
5.1.
Conclusion ................................................................................................................. 21
5.2
Recommendation....................................................................................................... 21
REFERENCES
ATTACHMENTS
vi
LIST OF TABLES
Table 1-1
Geographical Distribution of Daily Average Foreign Exchange Turnover....3
Table 4-1
Expected Return of Each Currency…………………………………………15
Table 4-2
Volatility of Each Currency .......................................................................... 15
Table 4-3
Variance – Covariance Table ........................................................................ 16
Table 4-4
Correlation Table of Each Currency ............................................................. 16
Table 4-5
Optimal Weighting of Each Currency ........................................................... 17
Table 4-6
Optimal Portfolios on Five Major Currencies ................................... ……... 18
Table 4-7
Value at Risk for Each Confidence Level ......................................... ……... 19
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LIST OF APPENDICES
APPENDIX A
HISTORICAL PRICE PER US DOLLAR FROM FEBRUARY 2010
TO APRIL 2010 (HOURLY)
APPENDIX B
RETURN PER US DOLLAR OF EACH CURRENCY FROM
FEBRUARY 2010 TO APRIL 2010 (HOURLY)
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