Spratt Co. (a U.S. firm) attempts to determine its economic exposure to movements in the British pound
Question:
Spratt Co.
(a U.S. firm) attempts to determine its economic exposure to movements in the British pound by applying regression analysis to data over the last 36 quarters:
where SP represents the percentage change in Spratt’s stock price per quarter, e represents the percentage change in the pound value per quarter, and μ is an error term.
Based on the analysis, the b0 coefficient is zero and the b1 coefficient is –.4 and is statistically significant. Assume that interest rate parity exists. Today, the spot rate of the pound is $1.80, the 90-day British interest rate is 3 percent, and the 90-day U.S. interest rate is 2 percent. Assume that the 90-day forward rate is expected to be an accurate forecast of the future spot rate. Would you expect that Spratt’s value will be favorably affected, unfavorably affected, or not affected by its economic exposure over the next quarter?
Explain.
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