Exchange Rates (USD/KRW) and Korean Stocks

What is an Exchange Rate?

The USD/KRW exchange rate indicates the amount of Korean won needed to buy 1 US dollar. If the exchange rate rises from ₩1,300 to ₩1,400, it means more won are required to purchase the same $1, signifying a decrease in the won's value. This is referred to as a weaker won (or stronger dollar).

Conversely, if the exchange rate falls from ₩1,300 to ₩1,200, fewer won are needed to buy $1, indicating an increase in the won's value. This is called a stronger won. Understanding that a larger number means a weaker won and a smaller number means a stronger won will make subsequent interpretations easier.

This article is for educational purposes to help understand the relationship between exchange rates and stocks, and it does not recommend any specific trades.

How Exchange Rates Affect Foreign Investor Returns

Foreign investors manage their funds in dollars. To buy Korean stocks, they must first convert dollars to won, and when they sell and exit, they convert won back to dollars. Therefore, a foreign investor's final return reflects not only stock price fluctuations but also exchange rate changes.

For example, suppose a foreign investor buys a stock at $50,000 per share when the exchange rate is ₩1,000. If the stock price remains unchanged but the exchange rate rises to ₩1,250, converting the same ₩50,000 back to dollars would result in a decrease from $50 to $40, representing an approximate 20% loss.

In other words, if the won weakens, foreign investors can incur exchange rate losses even if stock prices do not fall. Conversely, if the won strengthens, they can gain exchange rate profits even if stock prices remain flat. For foreign investors, Korean stocks are an asset where two bets—stock price and exchange rate—are intertwined.

Interpreting Exchange Rates and Foreign Investor Flows

In phases where the exchange rate rises rapidly (weaker won), foreign investors are likely to sell due to concerns about further exchange rate losses. This selling can, in turn, increase demand for dollars, pushing the exchange rate even higher, creating a vicious cycle. This is why we often observe periods of sharp exchange rate increases coinciding with net selling by foreign investors.

Conversely, if the won begins to strengthen, expectations of exchange rate gains can make it easier for foreign capital to flow in. However, this is only an average tendency; even with the same rise in the exchange rate, the supply and demand response can differ depending on whether the underlying cause is a US interest rate hike or a risk specific to Korea.

Therefore, it's important to consider not just the exchange rate figure itself, but also 'why it's moving.' A situation where all emerging market currencies weaken due to a strong global dollar has a completely different meaning than a situation where only the Korean won weakens.

Varying Exchange Rate Impacts Across Industries

The impact of exchange rates can also work in opposite ways for different companies. For companies with a high proportion of exports, a weaker won can be favorable when converting dollar-denominated sales into won, potentially increasing profits. Conversely, for companies that import raw materials or components in dollars, or those with significant foreign currency debt, a weaker won increases costs and burdens.

For example, an export company that earns 80% of its revenue in dollars might see an increase in won-denominated sales and improved margins if the exchange rate rises by 10% from ₩1,200 to ₩1,320, even if the volume sold remains the same. The same exchange rate change would result in higher costs for import-dependent companies.

Therefore, the simplistic notion that 'a rising exchange rate is bad for the stock market' is risky. It's necessary to develop the habit of separating the impact on foreign investor flows at the index level from the impact on individual companies' earnings.

Common Pitfalls in Interpretation

First, do not assume correlation implies causation. Just because exchange rates and foreign selling moved on the same day does not mean one caused the other. Common factors, such as US interest rates or risk aversion sentiment, could have influenced both simultaneously.

Second, foreign investors are not a monolithic entity. Funds that have hedged against currency risk will react less sensitively to exchange rate fluctuations, so you cannot predict the behavior of all foreign investors based solely on exchange rates.

Third, exchange rates often move concurrently with or lagging stock prices, rather than acting as a leading indicator. It is safer to use exchange rates as one context among various macroeconomic and company-specific indicators, rather than trying to time trades based on this single variable.

Key Takeaways

Remember that a larger exchange rate number indicates a weaker won, while a smaller number indicates a stronger won, and foreign investor returns reflect both stock prices and exchange rates. While net selling by foreign investors is common during periods of a weaker won, this is not always the case.

Exchange rate changes can be favorable for export-oriented stocks but unfavorable for import-dependent companies or those with foreign currency debt, so it's important to distinguish between index-level supply/demand and individual company earnings. Furthermore, considering the background of 'why' the exchange rate is moving, and avoiding definitive conclusions based on a single variable, will improve the accuracy of your interpretation.