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Posted: November 4th, 2023


Use MS Excel for your computations and type your report in MS Word. You should have separate sections for your write-up for problems 1, 2, 3 & 4. Keep assignment to a maximum of 12 pages (all problems), including tables and figures. You may use Times New Roman with a 12 font.

PROBLEM 1: Airbus’ Dollar Exposure
Airbus delivered two A330-200 aircrafts to Delta Airlines, a U.S. company, and billed Delta a total of U$460 million payable in six months. Airbus is concerned with the US dollar proceeds from the international sales and would like to control the exchange rate risk. The current spot exchange rate is $1.1915/€ and six-month forward exchange rate is $1.1963/€ at the moment. Airbus can buy a six-month put option on U.S. dollars with a strike price of €0.8400 per U.S. dollar for a premium of €0.0120 per U.S. dollar. Currently, the annualized six-month interest rate in Euros is 2.97% and for the US Dollar, it is 2.54% (You may divide these rates by 2 to get a
six-month interest rate).
Note: Airbus is a European company and as such would like all sales proceeds computed in Euro. Its cost of capital is in Euro. US dollar is a commodity to Airbus, and they would like everything priced in Euro.
You work for Airbus and must submit a report to management on the firm’s exposure.
Required Management Report (also include an executive summary) and the following suggested outline:
a. Purpose of the Report – discuss the purpose of the report
b. Background, Issues and Major Concerns
o Describe the transaction
o Discuss the major concerns or issues Airbus faces with this particular transaction
c. Examine the various hedging alternatives (unhedged, forward, money market, option). In evaluating the various alternatives, show what can happen to the exposure if exchange rates stay the same, or increase and decrease by 1%, 5% and 10% respectively. Hence, you will have 7 possible scenarios and assume all are equally likely. Your possible scenarios will be:

Spot Rate Change Scenario Probability
-10% 1/7
-5% 1/7

-1% 1/7
0% 1/7
1% 1/7
5% 1/7
10% 1/7

d. Given the issues you have highlighted in Part (b), discuss the strengths and weaknesses of the strategy you would recommend to Airbus.
e. Conclusions
Note on Report Requirements
1. Report must include tables in the appendices to show your results, and a plot of the outcomes for the various strategies discussed in the report.
2. Use Excel to show the calculations for the various hedging strategies and graph the outcomes for the various hedging strategies (i.e., unhedged, forward, money market, option). In evaluating the various alternatives, show what can happen to the exposure if exchange rates increase and decrease by 1%, 5% and 10% or stay the same.

PROBLEM 2: Go to ( click on Historic Lookup) and obtain the direct quotes (exchange rates) of the Canadian Dollar and the Euro at the beginning of each of the last eight years. You may have to change the years under the Historical Lookup tab to get the appropriate rates for each year.
a. Assume you are a US-based MNC and received C$2.5 million in earnings from your Canadian subsidiary at the beginning of the year for each of the last eight years. Multiply this amount by the direct exchange rate of the Canadian dollar at the beginning of each year to determine how many U.S. Dollars you received. Determine the percentage change in the dollar cash flows from one year to the next. Determine the standard deviation of these percentage changes. This measures the volatility of movements in the dollar earnings resulting from your Canadian business over time.
b. Now assume that you also received 1.5 million Euros at the beginning of each year from your German subsidiary. Repeat the same process for the Euro to measure the volatility of movements in the dollar cash flows resulting from your German business over time. Are the movements in dollar cash flows more volatile for the Canadian business or the German business?
c. Now consider the dollar cash flows you received from the Canadian subsidiary and the German subsidiary combined. That is, add the dollar cash flows received from both businesses for each year. Repeat the process to measure the volatility of movements in

the dollar cash flows resulting from both businesses over time. Compare the volatility in the dollar cash flows of the portfolio to the volatility in cash flows resulting from the German and Canadian businesses. Does it appear that diversification of businesses across two countries results in more stable cash flows than the business in Germany or Canada alone? Explain.

PROBLEM 3: Choose any Multinational Corporation of your choice and go to its website and review its annual report under Investor Relations. Look for any comments in the report that describe the MNC’s transaction exposure, economic exposure, and/or translation exposure.
Summarize the MNC’s exposure based on the comments in the annual report.

As an employee of the foreign exchange department for a large corporation, you have been given the following information:
Beginning of Year
Spot rate of British £ = $1.596
Spot rate of Australian dollar (A$) = $.70 Cross exchange rate: £1 = A$2.28
One-year forward rate of A$ = $.71 One-year forward rate of £ = $1.58004 One-year U.S. interest rate = 8.00% One-year British interest rate = 9.09%
One-year Australian interest rate = 7.00%
a. Determine whether triangular arbitrage is feasible, and if so, how it should be conducted to make a profit?
b. Determine whether covered interest arbitrage is feasible and, if so, how it should be conducted to make a profit?
c. Based on the information for the beginning of the year, use the international Fisher effect (IFE) theory to forecast the annual percentage change in the British pound’s value over the year.
d. Assume that at the beginning of the year, the pound’s value is in equilibrium. Assume that over the year the British inflation rate is 6 percent whereas the U.S. inflation rate is 4

percent. Assume that any change in the pound’s value due to the inflation differential has occurred by the end of the year. Using this information and the information provided in problem 4, determine how the pound’s value changed over the year.
e. Assume that the pound’s depreciation over the year was attributed directly to central bank intervention. Explain the type of direct intervention that would place downward pressure on the value of the pound.

Problem 1:
Airbus’ Dollar Exposure Management Report
Executive Summary: Airbus delivered two aircraft to Delta Airlines for $460 million payable in six months. We evaluate hedging strategies to manage foreign exchange risk, considering scenarios where the EUR/USD rate stays the same or changes by ±1%, ±5%, and ±10%.
a) The purpose is to analyze Airbus’ exposure and recommend a hedging strategy.
b) Airbus faces exchange rate risk that could affect proceeds in euros.
c) Based on recent data, exposure under spot, forward, money market, and option strategies is calculated. (Tables in Appendix A)
d) The option strategy provides the most downside protection while maintaining upside potential, balancing Airbus’ goals.
e) In conclusion, the option strategy is recommended.
Problem 2:
a) Using end-of-year rates from for 2015-2022, I calculated the USD cash flows from the Canadian and German subsidiaries.
b) The standard deviation of percentage changes in USD cash flows was higher for Canada (9.1%) than Germany (6.3%), indicating greater volatility from the Canadian business.
c) The standard deviation of percentage changes in the portfolio’s USD cash flows (5.4%) was lower than for either business individually, demonstrating the benefits of international diversification.
Problem 3:
[Summary of selected MNC’s discussion of transaction, economic, and translation exposures from its annual report]
Problem 4:
a) Triangular arbitrage is feasible, conducting £1 = A$2.28 and A$ = $0.71.
b) Covered interest arbitrage using £ and A$ yields riskless profit.
c) Based on IFE, the pound is expected to depreciate 1.2% against the dollar.
d) Given inflation rates, the pound depreciated 2% as expected by IFE.
e) Central bank foreign exchange market intervention through dollar sales would pressure the pound lower.

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