Short- and Long-Run Exchange Rate Risk Exercise Worksheet
Short- and Long-Run Exchange Rate Risk Exercise Worksheet (v1.2)In this exercise you are asked to choose a currency in which it is
assumed you have foreign exchange exposure both in trade (short-run)
and investment (long-run). In this exercise you are asked to find both
spot and forward exchange rates for a chosen currency and also
inflation rates associated with that currency. You are encouraged to
read through the exercise first before choosing your currency to
ensure the requested data is accessible via the links provided. 1. Short-Run Exchange Rate Risk Assume you have a trade receivable denominated in a foreign currency
of your choice that is payable to you by your customer in 6 months. At
the current spot rate the trade receivable is worth the equivalent of
US$5,000,000. To find the current spot rate for the chosen currency
pair go to http://www.hsbcnet.com/gbm/fxcalc-disp. Enter 5,000,000 in
the “Convert” box, United States dollar in the “From:” box, and your
chosen currency in the “To:” box. Click on “Go” for the spot rate,
which will be expressed in European terms, that is, units of foreign
currency per one US dollar. Enter the name of the chosen currency, the
date the site is accessed, and the spot rate in European terms in the
table below. To find a 180 day forward rate for the currency pair, go to
http://www.hsbcnet.com/gbm/fwcalc-disp#.For “Amount” you can just
enter 1 and enter US dollars in the “Buy” box and the foreign currency
in the “Sell” box. For “Value Date” enter “6 Months” and click “Go”
for the forward rate. (Clicking on the Inverse box will switch the
rate from European to American terms.) Enter the one-year forward rate
in the table below. Make sure the forward rate is expressed in the
same way as the forward rate, that is, in European terms. Foreign Currency Date Current Spot Rate in European terms:
FX per 1 US dollar Six -Month Forward Rate in European terms: FX per 1 US dollar
Based on the data above, answer the following questions:
a) At the current spot rate how much in the foreign currency are
you owed in 6 months?
b) Assuming you fully hedge your FX exposure in the forward
market, how many US dollars will you receive in 6 months?
c) Is the foreign currency selling in the forward market at a
premium, i.e. it appreciates relative to the spot rate, or a discount,
i.e., it depreciates relative to the spot rate? Provide numbers to
support your answer.
2. Long-Run Exchange Rate Risk Assume you have undertaken a 3-year investment abroad with expected
cash flows denominated in your chosen currency. At the current spot
rate those cash flows are expected to provide a positive net present
value (NPV) in US dollar terms. Based on relative purchasing power
parity you are asked to estimate future spot rates over the next three
years based on comparative inflation data. With that data complete the
S0 = Current Spot Rate in European Terms (Foreign currency per US
dollar) E(St) = Expected Exchange Rate Spot Rate in t Years in
European Terms (Foreign currency per US dollar) hUS= Annual Inflation
Rate in the United States hFC = Annual Foreign Country
Using the data above and textbook equation (18.3) E(St) = S0 ∙ [1 +
(hFC – hUS)]tand assuming the estimated inflation rate in Year 1 also
holds for Years 2 and 3, please respond to the following:a) Based on relative purchasing power parity, estimate S1.
b) Based on relative purchasing power parity, estimate S2.
c) Based on relative purchasing power parity, estimate S3.
d) Based on relative purchasing power parity, has the foreign
currency appreciated or depreciated against the US dollar? Explain.
e) Based on relative purchasing power parity, has the NPV of the
investment project increased or decreased in US dollar terms? Explain.