Exhibit 10-2
Volusia, Inc. is a U.S.-based exporting firm that expects to receive payments denominated in both euros and Canadian dollars in one month. Based on today's spot rates, the dollar value of the funds to be received is estimated at $500,000 for the euros and $300,000 for the Canadian dollars. Based on data for the last fiF t y months, Volusia estimates the standard deviation of monthly percentage changes to be 8 percent for the euro and 3 percent for the Canadian dollar. The correlation coefficient between the euro and the Canadian dollar is 0.30.
-Refer to Exhibit 10-2. Assuming an expected percentage change of 0 percent for each currency during the next month, what is the maximum one-month loss of the currency portfolio? Use a 95 percent confidence level and assume the monthly percentage changes for each currency are normally distributed.

Question

Quizplus · Accepted Answer

The maximum one-month loss of the currency portfolio is -9.00 percent. This is calculated using the formula:Maximum loss = -Z * sqrt(variance of portfolio)where:Z = the z-score for the desired confidence level (95% in this case)variance of portfolio = the variance of the portfolio, which is calculated as:variance of portfolio = w1^2 * variance of currency 1 + w2^2 * variance of currency 2 + 2 * w1 * w2 * correlation coefficient * standard deviation of currency 1 * standard deviation of currency 2In this case, w1 = 500,000 / (500,000 + 300,000) = 0.625, w2 = 300,000 / (500,000 + 300,000) = 0.375, variance of currency 1 = 0.08^2, variance of currency 2 = 0.03^2, and correlation coefficient = 0.30.Plugging these values into the formula, we get:variance of portfolio = 0.625^2 * 0.08^2 + 0.375^2 * 0.03^2 + 2 * 0.625 * 0.375 * 0.30 * 0.08 * 0.03 = 0.0036Maximum loss = -1.96 * sqrt(0.0036) = -9.00%

Exhibit 10-2 Volusia, Inc. Is a U.S.-Based Exporting Firm That Expects to Expects