Assume that Mill Corp., a U.S.-based MNC, has applied the following regression model to estimate the sensitivity of its cash flows to exchange rate movements: PCF_t = a₀ + a₁e_t + $\mu$_t Where the term on the left-hand side is the percentage change in inflation-adjusted cash flows measured in the firm's home currency over period t, and e_t is the percentage change in the exchange rate of the currency over period t. The regression model estimates a coefficient of a₁ of 2. This indicates that if the foreign currency: A) appreciates by 1 percent, Mill's cash flows will decline by 2 percent. B) appreciates by 1 percent, Mill's cash flows will decline by .2 percent. C) depreciates by 1 percent, Mill's cash flows will increase by 2 percent. D) depreciates by 1 percent, Mill's cash flows will decline by 2 percent. E) None of these are correct.

Question

Quizplus · Accepted Answer

The coefficient of a₁ being 2 indicates that for a 1% increase in exchange rate (appreciation of foreign currency), Mill's cash flows will decrease by 2%. Therefore, for a 1% decrease in exchange rate (depreciation of foreign currency), Mill's cash flows will decrease by -2% or 2%.

Assume That Mill Corp μ\muμ t Where the Term on the Left-Hand Side

Assume That Mill Corp $\mu$ _t

Where the Term on the Left-Hand Side