Chapter 10 Example In-Class
A) Your company has a net exposure of 515,000 Euros inflows due in 60 days. You expect payment in 60 days at which time your company will convert the Euros into US dollars.
The current Spot rate on the Euro is $1.10
Your company has assumed that the expected spot rate on the Euro in 60 days will be selling at the same rate as today. In other words, the expected change in the spot rate over the next 60 days is 0.0%. However, the standard deviation of the expected change in the spot rate is 11% per year (4.5% per 60 days)
What is the expected value of the 515,000 Euros in 60 days? What is the 95% Value-at-Risk measure in US dollars for this transaction? Remember that a 5% one-sided tail is approximately 1.65 standard deviations away from the mean.
B) Your company has a net exposure of 320,000 Euros outflows to be paid in 90 days. You will wait 90 days to make the payment.
The current Spot rate on the Euro is $1.12
Your company has assumed that the expected spot rate on the Euro in 90 days will be selling at the same rate as today. In other words, the expected change in the spot rate over the next 90 days is 0.0%. However, the standard deviation of the expected change in the spot rate is 12% per year (6% per 90 days)
What is the expected cost of the 320,000 Euros in 60 days? What is the 95% Value-at-Risk measure in US dollars for this transaction? Remember that a 5% one-sided tail is approximately 1.65 standard deviations away from the mean.
C) Suppose your company has the following currency inflows and outflows over the next month:
Inflows Outflows Net Expected FX Rate $ exposure
Euros 10 million 15 million $1.10/1Euro
GBP 22 million 19 million $1.50/1GBP
Assume the Euro and Pound has a correlation coefficient of 0.91 in their monthly movements against the dollar. What is your approximate net US dollar exposure over the next month?
Is your company worried about the dollar strengthening or weakening over the next month?
Briefly describe a hedge position that would be appropriate?
Example questions:
1) Magent Co. is a U.S. company that has exposure to Euro and Pound. It has net inflows of 20 million Euros and net outflows of 18 million pounds next month. The present exchange rate of the Euro is $1.12/1 Euro while the present exchange rate of the Pound is $1.28/1GBP. Magent Co. has not hedged these positions.
i. What is the net inflow or outflow for Magent Company as measured in US dollars?
$______
ii. The Euro and Pound are highly correlated in their movements against the dollar. If the US dollar weakens (both foreign currency strengthens), will Magent Co. benefit from the exchange rate movement or be adversely affected by the exchange rate movement?
Circle One : Benefit or Be Adversely Affected
2) Your US Company has just purchased a large quantity of parts from a German company for 2.0 million Euros. Your company will make the payment of 2.0 million Euros in 90 days. The current Spot rate on the EUR is $1.14 ($1.14/1 EUR)
Your company has assumed that the expected spot rate on the EUR in 90 days will be the same as the spot price today (The expected change in the spot rate over the next 90 days is 0.0%). However, the standard deviation of the expected change in the spot rate is 8% per year (4.0% per 90 days). Remember that a 5% one-sided tail is approximately 1.65 standard deviations away from the mean. Assume this transaction is the only international transaction your company is engaged in.
b. What is the expected US dollar cost of the 2.0 million EUR paid in 90 days?
Expected US Dollar = $______
c. Are you worried that the Euro will strengthen or weaken over the next 90 days if you leave the position “unhedged”
Worried that Euro will (strengthen weaken )
d. What is the 95% “worst case” for the exchange rate of the Euro in 90 days according to your assumptions?
95% Worst Case Euro will be trading at $______/1 Euro
e. What is the 95% Value-at-Risk measured in US dollars for this transaction?
95% Value at Risk = $ ______