PowerShares has three basket currency investments. The DB U.S. Dollar Bullish Fund (UUP) and its bearish equivalent (UDN) use currency futures contracts to go long or short the U.S. dollar against a basket of six major currencies. The DB G10 Currency Harvest Fund (DBV) is a carry-trade investment that seeks to exploit the appreciation potential of high-yielding currencies versus low-yielding currencies. The funds can realize gains during the year as positions are liquidated or rolled. Sixty percent of the gains from the futures contracts are subject to long-term capital gains treatment, while 40% of the gains are taxed at less favorable short-term rates.

The WisdomTree/Dreyfus lineup includes ETFs based on the Brazilian real, emerging currencies, the euro and the Chinese yuan. The developed market products invest very short-term investment-grade money market securities denominated in the non-U.S. currency specified in its name. Because money market securities are less readily available in emerging markets, the ETFs use a combination of U.S. money market securities and forward currency contracts.

Barclays and Market Vectors offer single-country and group currency products structured as exchange-traded notes, or ETNs. The notes, structured as debt instruments, are designed to track currency moves more precisely than ETFs but expose shareholders to the risk of the bank that backs them. (For more information on the pros and cons of ETNs, see "Wading Back In," Financial Advisor, September 2009.) ProShares weighs in with four volatile ETFs that use leverage to enhance movements of the dollar against the yen and euro.

Any currency ETF investment is only profitable if currency moves, which are notoriously difficult to predict, play out. For much of 2009, a weakening dollar provided a tailwind for the U.S. stock market, since it increases profits for U.S. companies that do business overseas. On the other hand, the dollar's rally against the euro from 1.60 in mid-2008 to 1.25 in 2009 illustrates how boldly, and quickly, a trend can reverse. If a U.S. economic recovery outpaces recoveries in Europe and other overseas locales, the U.S. dollar would likely appreciate against other currencies. If that happens, the appeal of many of the ETFs on the market would head south.

 

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