Your employer, a large MNC, has asked you to assess its transaction exposure. It
ID: 2465660 • Letter: Y
Question
Your employer, a large MNC, has asked you to assess its transaction exposure. Its projected cash flows are as follows for the next year:
Currency
Total Inflow
Total Outflow
St (USD/FC)
Danish krone (DKK)
DKK 50,000,000
DKK 40,000,000
USD .15
British pound (GBP)
GBP 1,000,000
GBP 2,000,000
USD 1.50
Calculate the Net Transaction Exposure (NTE).
a) Assume that the movements in the DKK and the GBP are highly correlated. Provide your assessment as to your firm’s degree of transaction exposure (as to whether the exposure is high or low). Substantiate your answer.
b) Suppose the correlation is equal to 1 –i.e., perfect positive correlation. Suppose the GBP appreciates to 1.65 USD/GBP. What is the new NTE? What is the change in NTE?
c) Suppose the correlation is equal to -1 –i.e., perfect negative correlation. Suppose the GBP appreciates to 1.65 USD/GBP. What is the new NTE?
Currency
Total Inflow
Total Outflow
St (USD/FC)
Danish krone (DKK)
DKK 50,000,000
DKK 40,000,000
USD .15
British pound (GBP)
GBP 1,000,000
GBP 2,000,000
USD 1.50
Explanation / Answer
Answer:
a)
If the movements are DKK and GBP are highly correlated, the exposer would be low. It is because both of them will move in same direction and cause the offset in increase in net inflow with increase in net outflow.
b)
If the correlation is eqaul to 1, then NTE will remain at Zero. Becauase the exact positive increase in $ exposer due to DKK will be nullified by exact decrease in negetive $ exposer due to GBP. The net effect will be nil.
c)
If the correlation is eqaul to -1, with GBP appreciating to 1.65 USD/GBP (by 10%) then DKK will depreciate to 0.135(by 10%). The NTE will be:
Currency Net Inflow Exchange rate Value of Exposure(in USD) Danish krone (DKK) DKK 10,000,000 USD 0.15/DKK 1500000 British pound (GBP) (GBP 1,000,000) USD 1.50/GBP -1500000 NTE = 0Related Questions
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