Question Details

The Hong Kong dollar is presently pegged 



1. Cross-Currency Relationships. The Hong Kong dollar (HK$) is presently pegged to the U.S.
dollar and is expected to remain pegged. Some Hong Kong firms export products to Australia that
are denominated in Australian dollars and have no other business in Australia. The exports are not
hedged. The Australian dollar is presently worth 0.50 U.S. dollars but you expect that it will be
worth 0.45 U.S. dollars by the end of the year. Based on your expectations, will the Hong Kong
exporters be affected favorably or unfavorably? Briefly explain.

2. Interpreting Economic Exposure. Spratt Co. (a U.S. firm) attempts to determine its economic
exposure to movements in the British pound, by applying regression analysis to data over the last
36 quarters:
SP = b0 + b1e + u
where SP represents the percentage change in Alabama- stock price per quarter, e represents the
percentage change in the pound value per quarter, and u is an error term. Based on the analysis,
the b0 coefficient is zero and the b1 coefficient is -.4 and is statistically significant. Assume that
interest rate parity exists. Today, the spot rate of the pound is $1.80, the 90-day British interest
rate is 3%, and the 90-day U.S. interest rate is 2%. Assume that the 90-day forward rate is
expected to be an accurate forecast of the future spot rate. Would you expect that Spratt- value
will be favorably affected, unfavorably affected, or not affected by its economic exposure over the
next quarter? Explain.



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