ABC Corp., a US-based MNC, expects to receive substantial payments denominated in the Polish zloty and the Brazilian real in 1 month. Based on today’s spot rates, the dollar value of funds to be received is estimated at $600,000 for the zloty and $400,000 for the real. Based on estimates from ABC Corp.’s treasury using historical data, the standard deviation of monthly changes for the zloty is found to be 7%, while for the real it is found to be 8%. The correlation coefficient between the two currencies is found to be 0.5.
a) Quantify ABC Corp.’s exchange rate exposure using portfolio standard deviation.
b) What if the correlation coefficient were -0.5 instead? How does the portfolio standard deviation compare to the individual standard deviations of the two currencies? Comment briefly