10. You are given the following monthly, continuously compounded return (x 100) data

on the USDEUR exchange rate:

monthly S_t,$/ S_t,/$

mean 0.11 -0.11

variance 8.27 8.27

std dev 2.88 2.88

a. Calculate the annualized mean, variance and standard deviation for the USD rates of

appreciation / depreciation.

Suppose you manage an international fixed income portfolio denominated in euros for

Deutsche Bank in Frankfurt. It is the end of August 2017. Having invested in US

Treasury Bonds in the past, you will be receiving $100 million at the end of August 2018.

Assume there is no chance the US government will default on this payment.

b. Using your answer from part (a), what is your expectation of the spot exchange rate

at which you will transact in August 2018 if you do not hedge transactions exchange risk

and the exchange rate in August 2017 is St,$/

= 1.2190?

c. What is the nature of the risk of this position?

d. Your manager would like to know the value at risk for this position. Assume the rate

of appreciation of the USD relative to the EUR over the next year will be normally

distributed with the means, standard deviations and variances you calculated above.

What is the value at risk (VaR) at the 5% level?

e. What cautions would you provide to your manager regarding this VaR analysis?