3. Suppose that you work for a U.S. based MNC that exports items to both Canada and Mexico. 75% of all net cash inflows are denominated in Canadian Dollars (C$) and 25% of all net cash inflows are denominated in Mexican Pesos (MXN). Suppose that the historical correlation between the Canadian dollar and Mexican peso over the last three years has been 0.65. Also, assume that over the same three-year time period the monthly standard deviation of the Canadian dollar was 2.4% and the monthly standard deviation of the Mexican peso was 3.9%. Assume that your firm uses a simple market-based forecast for both the Canadian dollar and the Mexican peso whereby next months spot rate is assumed to be the same as the current months spot rate.

1. Calculate the monthly standard deviation of the currency portfolio. (10 points)

2. What is the one-month expected percentage change in the value of the currency portfolio. (6 points)

3. Using a 95% confidence level, calculate the maximum one-month loss for the Canadian dollar, the Mexican peso and the currency portfolio. (15 points).

4. Why is the maximum loss for the currency portfolio not simply equal to the weighted average of the maximum expected losses for the Canadian dollar and the Mexican peso? Think: fundamental principle learned in Essentials of Finance (5 points)