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Exchange Rate: Effects on Profitability and Hedging Risk

The exchange rate risk is the risk to which investors are exposed because changes in exchange rates may have an effect on investments that they have made. Because of the risk, an investor can lose capital in the currency trading market. Therefore, it important to hedge the currency risk.

What is the value of your $202,995 portfolio of your country's currency now?
Click here (http://www.oanda.com/currency/historical-rates/) and collect the following information: A.The daily currency values (how much currency you get for $1) for the last week,
The currency values for the last week of last year, and
The currency values for the last week of two years ago.

Based on your analysis and findings, what would you recommend to the American companies doing business in your chosen country? Should American companies doing business in your chosen country hedge their currency risk or not?

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Solution Preview

We choose Canadian dollar (CAD) as an example. For the week from Aug 24 to 30 of the three years, the daily midpoint currency values are listed as follows.
Year 2014 2013 2012
Aug-24 1.0944 1.0533 0.9911
Aug-25 1.0944 1.0498 0.9931
Aug-26 1.0963 1.0498 0.9921
Aug-27 1.0969 1.0510 0.9921
Aug-28 1.0906 1.0511 0.9908
Aug-29 1.0854 1.0489 0.9891
Aug-30 1.0857 1.0503 0.9884
Weekly Average 1.0919 1.0506 0.9909
It is obvious that CAD depreciated against USD over the ...

Solution Summary

The solution illustrates how the change in exchange rate affects a company's profitability. It also describes different ways to hedge exchange rate risk