Coursework 2

You work as an economist in a big US MNC that has global operations in Australia,
Brazil, Europe, UK, Japan and South Africa.

The company would like to measure its foreign exchange exposure over the next
quarter and if these exposures are beyond a certain limit, the company would like to
implement a hedging program. This helps the company to reduce its foreign exchange
risks to acceptable levels so its cash flows and thus its value are not affected.

The company estimates that $100 million net collection of foreign currency in US dollars
over the next quarter distributed as follows: $20 million of Australian Dollar, $15 million
of Brazilian Riyals, $20 million of EUROs, $15 million of British Pounds, $20 million of
Japanese Yen and $10 million of South African Rand.

To measure currency losses that can be realized in a bad quarter, the company would
like to compute value at risk at the 5% and 1% level. In particular, the risk management
team of the company would like to assess the dollar losses that the company will
experience on its foreign currency that is exceeded 5% and 1% of the times
respectively. If the losses that are exceeded 1% of the times are greater than $20
million, the company would like to hedge some foreign currency exposure using
derivatives.

Requirement:

1- Collect time series of monthly exchange rate of the dollar against the Australian
Dollar (AUD), Brazilian Real (BRL), Euro (EUR), Japanese Yen (JPY), South
African Rand (ZAR) and the UK pound (GBP). Collect for the last 10 years.

(20 Marks)

2- Compute VAR at the 5% and 1% level of the foreign currency exposures of the
company.

(60 Marks)
3- Discuss how the company may reduce its foreign exchange risks to the required
level using derivatives?

(20 Marks in Total)

(100 Marks in Total)