A US firm has a European branch in Germany and analyzes its cash flows in euro. Use the following exchange rate information to find the standard deviation of the euro movement.
12/31/2009: 1 euro = $1.16
12/31/2010: 1 euro = $1.21
12/31/2011: 1 euro = $1.19
12/31/2012: 1 euro = $1.24 (Today’s spot rate)
The annual US interest rate is 3% and the annual euro interest rate is 5%. Assuming that the IRP holds and the firm uses the forward rate to forecast the next year’s exchange rate, find the maximum 1-year percentage loss of the euro using the value-at-risk method and a 99% probability. Use the following normal distribution.
z = -1.65 => Probability = .05
z= -1.96 => Probability = .025
z= -2.33 => Probability = .01
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