Page 113 - DMGT549_INTERNATIONAL_FINANCIAL_MANAGEMENT

International Financial Management

Notes a corresponding and simultaneous effect on other currencies, it is assumed that in the long run
the factors will remain more or less stable. Thus, correlation among currencies can be expected
to be a good indicator of movement of exchange rates in respect of other foreign currencies.

Notes The concept of currency correlation can also be used to hedge transaction exposure
in some cases.

For example, if a MNC has cash inflows in one currency (say Deutschemark) and cash outflows
in a closely correlated currency like Swiss franc, the loss/gain on cash outflow due to an
appreciation/depreciation of the Swiss franc vis-à-vis the MNC’s home currency will be offset
to a certain extent by the gain/loss on the cash inflow due to the appreciation/depreciation of
the Deutschemark. Thus, if the MNCs expect that these two currencies will move in the same
direction and by nearly the same degree in the next period, the exposures to these two currencies
are partially offset. Such offset of one exposure against another in a closely related currency
provides a natural hedge. The currency correlation between EUR/USD is given in Table 7.2.
Table 7.2: EUR/USD Correlation Values

Task Calculate the currency correlation among the Asian currencies for the last 5 years.
You could calculate both the long-term and short-term correlation for the Asian currencies
being examined.

Self Assessment

State whether the following statements are true or false:
11. Currency correlation is the degree of simultaneous movements of two or more currencies
with respect to some base currency.
12. The concept of currency correlation can not be used to hedge transaction exposure.

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