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Estimating Currency Exposure and Standard Deviation for International Finance Transactions

This analysis focuses on an American company's exposure to four foreign currencies over the next quarter. By weighting the cash flows according to currency exposure and estimating the volatility of exchange rate movements, we build a variance/covariance matrix that accounts for correlations among the currencies. The resulting weighted variance matrix yields a variance of 0.00076536, leading to a portfolio standard deviation of 2.7665%. This methodology assists in evaluating currency risk and potential impacts on net cash flows.

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Estimating Currency Exposure and Standard Deviation for International Finance Transactions

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  1. International Finance Multiple Currency Transaction Exposure Bill Reese

  2. Estimate Net CFs in Each Currency • Example: This American company has exposure in four foreign currencies over the next quarter.

  3. Weight the Dollar Cash Flows Pound 15 15/16 = .9375 Can. $ 8 8/16 = .5 S. Krona -15 -15/16 = -.9375 Peso 8 8/16 = .5 16 The weights must add up to 1.0

  4. Estimate Volatility (standard deviation) of XR Movements over the Quarter British Pound – 2.8% Canadian Dollar – 2.7% Swedish Krona – 3.2% Mexican Peso – 3.5%

  5. Estimate the Correlations Between these Currencies over the Next Quarter

  6. Build a Variance/Covariance Matrix

  7. Build a Wtd. Var/Cov Matrix

  8. Determine the Portfolio Standard Deviation Variance = sum of cells in wtd. var/cov matrix = .00076536 Standard Deviation = Square Root of Variance = 2.7665%

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