How can you quantify currency risk in a floating exchange rate system?
What will be an ideal response?
To characterize the risk of a currency position, you must try to characterize the conditional distribution of the future exchange rate changes. With floating exchange rates, historical information provides useful information about this distribution. For example, you can use data to measure the average historical dispersion (standard deviation or volatility) of the distribution. The higher this volatility, the riskier are positions in this currency. It is also possible to rely on more forward-looking information using the options markets (see Chapter 20). Finally, we should point out that volatility is an adequate indicator of risk when exchange rate changes are approximately normally distributed. In reality, the distribution of exchange rate changes displays fat tails, even in floating exchange rate systems, and this increases the risk of currency positions.
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Fill in the blank(s) with correct word
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A. format, tone, and audience B. introduction, body, and conclusion C. direct, neutral, and indirect order D. all of these
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A) Disciplined B) Ethical C) Synthesizing D) Respectful
Vegan Foods Inc has a current capital structure of 30% debt, 70% equity, and are in a 40% tax bracket. However, after speaking with their investment bankers they have decided to increase their debt to 40% of total capital
Some of the firm's managers are concerned that there may an increase in risk for stockholders due to the increased financial obligations resulting from the increased debt load. Currently, the levered beta for the firm is 1.20. Use your knowledge of levered and unlevered betas to estimate the new levered beta for existing shareholders.