Question

Global Finance on December 31, 2018 had long positions of 300,000,000 Japanese Yen and 60,000,000 Swiss Francs. The closing exchange rates were ¥90/$ and Swf 1.87/$.

a. What were the respective positions of the two currencies in dollars? Show work and discuss.

b. What is the importance of exchange rates to a company in relation to risk? Give an example.

Answer 1

Given the exchnage rates 1 US dollar = 90 Yen So the value of 300,000,000 Yen in dollar would be equivalent to (300000000/90) 3,333,333.33 US Dollar 1.87 Swiss franc = 1 US dollar So the value of 60,000,000 Swiss franc in US dollar would be (60000000/1.87) 32,085,561.50 US Dollar

b) It is very important for companies to be able to manage currency risk especially whose position is exposed to more than one currency because if you are expected to receive funds in more than one currency then if exchange rate movement was unfavorable then you will have bear loss. Sometimes losses become so much that it might cause the situation of bankruptcy for the company especially financial companies whose exposure is significant. Managing currency risk exposure is not just important from the perspective of protecting your losses but it also helps in maximizing the gain on your position. Let’s say you have a long position and your position is now in gain of $1000,000, now you definitely want to gain more on that position but at the same time you want to make sure that because of the unfavorable movements your current gains are not eliminated. Managing currency exposure is also important because you should have capital so that in future you are able to make money, if your capital is eliminated in one position then you would not have funds to take further position and you would not be able to survive in the market. Let’s say you have a capital base 100,000,000 so you want your exposure in such a way that at once your portfolio is not exposed to more than 1% or 2% of total capital, that means in one trade you should not lose more than 1% or 2% of your capital.