Question

1. An MNC has the following net exposures to the euro and the British pound: a net inflow of 24million British pounds and a net outflow of 26.4 million euros. The spot current spot rates are $2500/£ and $1.1364/€. If the pound and euro are perfectly positively correlated in their movement against the U.S. dollar, will the company have high or low exposure to foreign exchange? Explain why either way.

If the net values were both net inflows and they perfectly positively correlated. Would the MNC have a high or a low level of exposure to foreign exchange? Explain

Answer 1

Inflow of 24 m pounds = 24 * 1.25 = $30 m

Outflow of 26.4 m euros = 26.4 * 1.1364 =  $30 m

So at present we can say we donot have any exposure as inflows just negate the outflows

We are given that, euro and pound have a perfect positively correlated in movement against dollar. We have inflow of pound and outflow of Euros.

If the dollar becomes stronger, pound would depreciate as well as euro would depreciate. Lets assume there is 2% depreciation of Euro, then we will also have 2% depreciation of pounds. Inflows decrease by 2% as well as outflows reduce by 2%, keeping net exposure again at Nil. This is true even if other 2 currency appreciates, which will have overall no exposure to the net outflow.

Hence, We can say that the company has low exposure to foreign exchange.