Measuring Exchange Rate Exposure in Class Questions

1) The current spot rate is one Euro = $1.30.

Suppose that you have the following regression of the EUR/UDS exchange rate

(standard errors in parentheses)

% Change($/E) = -.05 + 1.5 (Interest Differential) + .65(Growth Difference) + Error

(.006) (.57) (.2) (1.75)

Dependent Variable: Monthly % Change in the Exchange Rate ($/Euro)

Intercept: -.05 (.006)

US interest rate Euro interest rate: 1.5 (.57)

European Economic Growth US Economic Growth: .65 (.2)

The standard error of the regression is 1.75. Currently, the interest rate in the United States is 5% and the interest rate in Germany is 3%. (The interest rate differential is 2%.) The United States is expected to growth 1% faster than the Eurozone.

a) Calculate a point estimate for the percentage change in the exchange rate.

b) Calculate a 95% confidence interval for the exchange rate.

2) Suppose that you are importing BMWs from Germany. You have agreed to buy 200 cars at a price of E 40,000 apiece. Payment is due on delivery one month from now. Given your answer above, within what range will your costs lie?

3) Suppose that GM is exporting cars to both Great Britain and Switzerland.

Swiss Exports: CHF 300,000

British Exports: GBP 200,000

Currently, the British Pound is trading at $1.85 while the Swiss Franc is trading at $.84. We also have the following information:

GBP: Forecasted to depreciate by 2% with a standard deviation of 1.5%.

CHF: Forecasted to depreciate by 1% with a standard deviation of 2%.

Historically, the Changes in the British Pound have a correlation of .25 with changes in the Swiss Franc.

a) Calculate the distribution of GM revenues in one month.

b) Would GM be better off concentrating its sales in Britain ?

4) How can a company with no foreign transactions still find itself exposed to currency risk?

5) Estimating Value at Risk. Yazoo Inc. is a U.S. firm that has substantial international business in

Japan and has cash inflows in Japanese yen. The spot rate of the yen today is $.01. The yen exchange rate was $.008 three months ago, $.0085 two months ago, and $.009 one month ago. Yazoo uses todays spot rate of the yen as its forecast of the spot rate in one month. However, it wants to determine the maximum expected percentage decline in the value of the Japanese yen in one month based on the value at risk (VaR) method and a 95 percent probability. Use the exchange rate information provided to derive the maximum expected decline in the yen over the next month.

6) Walt Disney World built an amusement park in France that opened in 1992. How do you think this project has affected Disneys economic exposure to exchange rate movements? Think carefully before you give your final answer. There is more than one way in which Disneys cash flows may be affected. Explain.