Consider an MNC that is exposed to the Taiwan dollar (TWD) and the Egyptian pound (EGP); 25 percent of the MNC's funds are Taiwan dollars and 75 percent are pounds. The standard deviation of exchange movements is 7 percent for Taiwan dollars and 5 percent for pounds. The correlation coefficient between movements in the value of the Taiwan dollar and the pound is .7. Based on this information, the standard deviation of this two-currency portfolio is approximately:
A) 5.13 percent.
B) 2.63 percent.
C) 4.33 percent.
D) 5.55 percent.

Question

​Consider an MNC that is exposed to the Taiwan dollar (TWD) and the Egyptian pound (EGP); 25 percent of the MNC's funds are Taiwan dollars and 75 percent are pounds. The standard deviation of exchange movements is 7 percent for Taiwan dollars and 5 percent for pounds. The correlation coefficient between movements in the value of the Taiwan dollar and the pound is .7. Based on this information, the standard deviation of this two-currency portfolio is approximately:
A) ​5.13 percent.
B) ​2.63 percent.
C) ​4.33 percent.
D) ​5.55 percent.

Quizplus · Accepted Answer

The standard deviation of a two-currency portfolio can be calculated using the formula for the standard deviation of a portfolio with two assets:  σp = √(w₁²σ₁² + w₂²σ₂² + 2w₁w₂σ₁σ₂ρ₁₂)  where w₁ and w₂ are the weights of the assets, σ₁ and σ₂ are the standard deviations, and ρ₁₂ is the correlation coefficient.  Plugging in the values:  σp = √(0.25² * 0.07² + 0.75² * 0.05² + 2 * 0.25 * 0.75 * 0.07 * 0.05 * 0.7)  σp ≈ 5.13 percent.

​Consider an MNC That Is Exposed to the Taiwan Dollar

Consider an MNC That Is Exposed to the Taiwan Dollar