A currency ETF is an exchange-traded fund (ETF) that is designed to provide investors with exposure to a single currency or a basket of currency. The financial resources of the funds are pooled to provide exposure to the underlying currency (currencies) by tracking its (their) performance against a certain currency or a basket of currencies.
In its simplest form, an ETF might be backed by bank deposits in a foreign currency. Other more complex currency ETFs involve purchase of currency derivatives (particularly, currency forwards and currency swaps, which give the buyer the right to exchange a certain currency at a predetermined date) to establish foreign currency exposure.
The currency market used to be accessible only by institutional investors and very large funds (e.g., hedge funds). However, with currency ETFs, the currency market for major currencies is available all types of investors (particularly, small investors). An investor considering such products has evaluate benefits and risks involved.
The benefits (pros) include the ability to diversify an investor’s portfolio, particularly by adding investments denominated in other currencies that provide handsome returns.
On the cons side, currency ETFs are susceptible to multiple factors or variable, such as interest rates, geopolitical developments and events, and relevant economic factors. Any negative development as to such factors could negatively impact the value of these ETFs, and deprive the investors from prospective returns.
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