Page 117 - DMGT549_INTERNATIONAL_FINANCIAL_MANAGEMENT

International Financial Management

Notes

Task The concept of currency correlation is often used by MNCs to hedge transaction
exposure. Two mechanisms which are generally used by MNCs in covering their transaction
exposure are prediction of currency volatilities over time and finding out correlation
between currencies in which they are dealing. In this context calculate the correlation and
covariance coefficient between the Indian rupee and a few important currencies like dollar,
pound, euro, yen, etc.

Self Assessment

State whether the following statements are true or false:
13. Currency volatility will necessarily remain consistent from one time period to another.
14. When small values of one set are associated with large values of the other is negative
covariance.
15. Risk grades to currencies have been arrived at after determining their standard deviations.
16. HLPI is an important tool to measure the volatility of currencies.

Case Study Transaction Exposure – DC Corporation

C Corporation is a US-based software consulting firm, specialising in financial
software for several Fortune 500 clients. It has offices in India, the UK, Europe and
DAustralia. In 2002, DC required £100,000 in 180 days and had four options before
it:

A forward hedge
A money market hedge
An option hedge

No hedge
Its analysts developed the following information which was used to asses the alternative
solutions:

Current spot rate of pound = $ 1.50
180-day forward rate of pounds as of today = $ 1.48
Interest rates were as follows:
U.K U.S.
180-days deposit rate 4.5% 4.5%
180-days borrowing rate 5.1% 5.1%

The company also had the following information available to it:
A call option on Pound that expires in 180 days has an exercise price of $ 1.49 and a
premium of $ 0.03.
Contd...

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