Tutorial 9 Presentation Questions (Foreign Exchange Markets)
1. Describe the main types of risk facing an organization which has dealings in a foreign currency. Can all these risks be hedged, and should all these risks be hedged at all times ?
The main foreign exchange risks faced by the organization include :
* Short-Term Exposure
* The day-to-day fluctuations in exchange rates.
* Can be reduced or eliminated probably by the use of forward & futures exchange agreements, and other derivatives.
* Long-Term Exposure
* Usually comes from the unanticipated changes in relative economic conditions.
* Hedging is usually more difficult. One ...view middle of the document...
b. If the spot exchange rate 6 months later is NZ$1.05/A$, NZ$11 million in 6 months will be equivalent to A$10.48 million (11 million / 1.05), which means a profit of A$0.48 million.
c. We may use forwards to hedge foreign exchange risk by fixing the exchange rate now for settlement in a future period. Forward contracts are tailor-made but are not traded on organized exchange. There will be counter-party risk, just in case one of the parties does not honor the contract.
3. Suppose a U.S. investor plans to invest in a U.K. firm with stock price currently selling for 40 pounds per share. The investor has a budget of $10,000 and the current exchange rate is $2 / pound.
a. How many shares can this investor buy ?
b. Fill in the following table for rates of return after 1 year in each of the 9 scenarios.
c. When is the dollar-denominated return equal to the pound-denominated return ?
d. If all these 9 scenarios are equally likely, calculate the standard deviation for both pound-denominated & dollar-denominated rates of return.
Price per share (pounds) | Pound-denominated return (%) | Dollar-denominated return for Year-end Exchange Rate |
| | $1.80/pound...