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. Show your calculation. (1 point)

Period Yen Forecast Actual Yen Value Pound Forecast Actual Pond Value

1 $.0050 $.0051 $1.23 $1.26

2 .0048 .0050 1.23 1.20

3 .0053 .0052 1.25 1.27

4 .0055 .0056 1.28 1.22

(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 3-year annualized interest rate in the United States is 5% and the 3-year annualized interest rate in Singapore is 3%. Assume interest rate parity holds for a 3-year horizon. Assume that the spot rate of the Singapore dollar is $.72. If the forward rate is used to forecast exchange rates, what will be the forecast for the Singapore dollars spot rate in 3 years? What percentage appreciation or depreciation does this forecast imply over the 3-year period? (1 point)

3. Fundamental Forecasting Sulsa Inc. uses fundamental forecasting. Using regression analysis, it has determined the following equation for the euro eurot = b0 + b1INFt 1 + b2INCt 1 = .005 + 1.2INFt 1 + 0.7INCt 1 where eurot is the quarterly change in euros value, INFt-1 is the previous quarterly percentage change in the inflation differential, and INCt-1 is the previous quarterly percentage change in the 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 income 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? (1 point)

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 DK40,000,000 while outflows equal DK30,000,000. British pound inflows equal 3,000,000 while outflows equal 1,000,000. The spot rate of the krone is $.15, while the spot rate of the pound is $1.30. The standard deviation of exchange rate movements is 6% for krone and 4% for pound. Assume that the movements in the Danish krone and the British pound are highly correlated with a correlation coefficient of 0.80. Based on this information, what is the standard deviation of this two-currency portfolio, which you use to assess the firms transaction exposure? (1 point) (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. The weight for each currency = dollar value of the net position in the currency/total dollar value of the portfolio)

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? (1 point)

3. 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. (1 point)

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 300,000 pounds of payables due in 180 days. Assume the firm has no excess cash. Assume the spot rate of the pound is $1.24, and the 180-day forward rate is $1.25. The British interest rate is 3%, and the U.S. interest rate is 4% over the 180-day period. (round to whole dollars) (2 points)

2. Money Market Hedge on Receivables Assume that Parker Company will receive 200,000 Canadian dollars in 360 days. Assume the following interest rates: U.S. Canada 360-day borrowing rate 6% 5% 360-day deposit rate 4% 3% Assume the forward rate of the Canadian dollar is $.80 and the spot rate of the Canadian dollar is $.78. If Parker Company uses a money market hedge, how much U.S. dollars will it receive in 360 days from its Canadian dollar receivable? (round to whole dollars) (2 points)