Response to the following problem:
Go to www.oanda.com and obtain the direct exchange rate of the Canadian dollar and euro at the beginning of each of the last 7 years.
a. Assume you received C$2 million in earnings from your Canadian subsidiary at the beginning of each year over the last 7 years. Multiply this amount by the direct exchange rate of the Canadian dollar at the beginning of each year to determine how many U.S. dollars you received. Determine the percentage change in the dollar cash flows received from one year to the next. Determine the standard deviation of these percentage changes. This measures the volatility of movements in the dollar earnings resulting from your Canadian business over time.
b. Now assume that you also received 1 million euros at the beginning of each year from your German subsidiary. Repeat the same process for the euro to measure the volatility of movements in the dollar cash flows resulting from your German business over time. Are the movements in dollar cash flows more volatile for the Canadian business or the German business?
c. Now consider the dollar cash flows you received from the Canadian subsidiary and the German subsidiary combined. That is, add the dollar cash flows received from both businesses for each year. Repeat the process to measure the volatility of movements in the dollar cash flows resulting from both businesses over time. Compare the volatility in the dollar cash flows of the portfolio to the volatility in cash flows resulting from the German business. Does it appear that diversification of businesses across two countries results in more stable cash flows than the business in Germany? Explain.
d. Compare the volatility in the dollar cash flows of the portfolio to the volatility in cash flows resulting from the Canadian business. Does it appear that diversification of businesses across two countries results in more stable cash flow movements than the business in Canada? Explain.