Chapter 9

1.

Measuring Forecast Accuracy

You are hired as a consultant to assess a firms ability to forecast. The firm has developed a point forecast for two different currencies presented in the following table. The firm asks you to determine which currency was forecasted with greater accuracy.

Period Yen Forecast Actual Yen Value Pound Forecast Actual Pond Value

1 $.0050 $.0051 $1.50 $1.51

2 .0048 .0052 1.53 1.50

3 .0053 .0052 1.55 1.58

4 .0055 .0056 1.49 1.52

(hint: For each currency, compute the absolute forecast error as a percentage of realized (actual) value for each period, then calculate its average over the four periods. Compare the average forecast errors of the two currencies)

2.

Forecasting with a Forward Rate

Assume that the 4-year annualized interest rate in the United States is 9% and the 4-year annualized interest rate in Singapore is 6%. Assume interest rate parity holds for a 4-year horizon. Assume that the spot rate of the Singapore dollar is $.60. If the forward rate is used to forecast exchange rates, what will be the forecast for the Singapore dollars spot rate in 4 years? What percentage appreciation or depreciation does this forecast imply over the 4-year period?

3.

Fundamental Forecasting

Sulsa Inc. uses fundamental forecasting. Using regression analysis, it has determined the following equation for the euro

euro_t = b₀ + b₁INF_t-1 +b₂INC_{t-1 =} = .005 + .9INF_t-1 + 1.1INC_t-1

where euro_t is the quarterly change in euros value, INF_t-1 is the previous quarterly percentage change in the inflation differential, and INC_t-1 is the previous quarterly percentage change in he income growth differential. The most recent quarterly percentage change in the inflation differential between the U.S. and Europe was 2 percent, while the most recent quarterly percentage change in the in come growth differential between the U.S. and Europe was -1 percent. Based on this information, what is the forecast of the percentage change in euros value?

Chapter 10

1.

Assessing Transaction Exposure

Your employer, a large MNC, has asked you to assess its transaction exposure. Its projected cash flows are as follows for the next year. Danish krone inflows equal DK50,000,000 while outflows equal DK40,000,000. British pound inflows equal 2,000,000 while outflows equal 1,000,000. The spot rate of the krone is $.15, while the spot rate of the pound is $1.50. The standard deviation of exchange rate movements is 8% for krone and 5% for pound. Assume that the movements in the Danish krone and the British pound are highly correlated with a correlation coefficient of 0.90. Based on this information, what is the standard deviation of this two-currency portfolio, which you use to assess the firms transaction exposure?

(hint: to calculate the portfolio weights for each currency, first calculate the net positions (inflow/outflow) in each currency, and the dollar value of the net position in each currency.)

2.

Exposure of Domestic Firms

Why are the cash flows of a purely domestic firm exposed to exchange rate fluctuation? Are purely domestic firms subject to transaction exposure, translation exposure, and economic exposure?

3.

Factors That Affect a Firms Translation Exposure

What factors affect a firms degree of translation exposure? Briefly explain how each factor influences translation exposure.

4.

Economic Exposure

Longhorn Co. produces hospital equipment. Most of its revenue are in the United States. About half of its expenses require outflows in Philippine pesos (to pay for Philippine materials). Most of Longhorns competition is from U.S. firms that have no international business at all. How will Longhorn Co. be affected if the peso strengthens?

5.

Comparing Exposures

Erie Co., a U.S. based firm, has most of its business in the United States, except that it exports to Belgium. Its exports have been invoiced in euros (Belgiums currency). It has no foreign subsidiaries. Its main competition when selling to Belgiums customers is a company in Belgium that sells similar products, denominated in euros. Is Erie Co. subject to transaction exposure, translation exposure, and economic exposure? Starting today, Eire plans to adjust its pricing strategy to invoice its exports in U.S. dollars instead of euros. Based on the new strategy, how will Eries exposures to exchange rate risk change? Will Erie Co. be subject to economic exposure to exchange rate risk in the future? Briefly explain.

Chapter 11

1.

Money Market Hedge on Payables

Use the following information to calculate the dollar cost of using a money market hedge to hedge 200,000 pounds of payables due in 180 days. Assume the firm has no excess cash. Assume the spot rate of the pound is $1.52, the 180-day forward rate is $1.50. The British interest rate is 5%, and the U.S. interest rate is 4% over the 180-day period.

2.

Money Market Hedge on Receivables

Assume that Parker Company will receive SF200,000 in 360 days. Assume the following interest rates:

U.S. Switzerland

360-day borrowing rate 7% 5%

360-day deposit rate 6% 4%

Assume the forward rate of the Swiss franc is $.50 and the spot rate of the Swiss franc is $.48. If Parker Company uses a money market hedge, how much U.S. dollars will it

receive in 360 days from its Swiss franc receivable?