Question 1: Forecasting Exchange Rates

You have been recently hired as a financial analyst by TheVerve Co., a Canadian firm

dedicated to technological consulting. Recently, TheVerve has decided to invest 100 M

AUD into its music streaming business in Australia by the end of 2020. They expect to get

revenues for the next 4 years, with 4% return.

Richard Ashcroft, TheVerve's CEO asked you to explore if it is recommendable to take

hedge using CAD/AUD forwards or wait and buy the required AUD in the spot market at

the end of the year.

To decide in which market operate every year, two consulting companies where hired,

FXConsulting and ForeX Forecasting. The recommendations that they have provided to

their clients are resumed in the Exhibit A.

Exhibit A: Forecasting history and recommendations.

Year FX Consulting

Recommendation (a)

ForeX Forecasting

Recommendation (b)

Forward at T

for T+1 (c) Spot at T+1 (d)

2015 Forward Forward 1.09 1.06

2016 Forward Spot 0.94 0.93

2017 Spot Forward 0.99 0.98

2018 Spot Spot 0.96 0.95

Notes:

(a) and (b): Forward: the consulting company recommended at year T to contract the forward to trade

at T+1.

(c): Forward available at year T to trade at that rate in T+1.

(d): Spot rate available to trade at T+1.

All quotes are for the CAD/AUD exchange rate.

Today (end of 2018), ForEX Forecasting recommends waiting and trade in the spot market

at the end of 2020. On the other hand, FXConsulting recommends contracting the

available forward rate today, and eliminate the exchange rate risk.

BUS 418 - International Financial Management

2

Using the presented information. You must decide which of the recommendations to

follow. For this:

a) Calculate for each forecasting company the P&L for the full sample of forecasts,

and the average annual P&L.

b) Indicate which advice will you follow

c) Calculate the IRP forward rate if the spot rate is 0.98 CAD/AUD