Question

Cerra Co. expects to receive 5 million euros tomorrow as a result of selling goods to the Netherlands. Cerra estimates the standard deviation of daily percentage changes of the euro to be 1 percent over the last 100 days. Assume that these percentage changes are normally distributed. Use the value-at-risk (VaR) method based on a 95 percent confidence level. What is the maximum one-day loss in dollars if the expected percentage change of the euro tomorrow is 0.5 percent? The current spot rate of the euro (before considering the maximum one-day loss)

Answer 1

$58,075

Explanation:

Given:

Expected amount to be received = 5 million euros

Standard deviation of daily percentage change of euros, σ = 1%

Confidence level = 95%

Expected percentage change of the euro tomorrow = 0.5 percent

let,

the current spot rate of the euro (before considering the maximum one-day loss = $1.01

Now,

The maximum one-day percentage loss

= Expected change of euro - 1.65 × σ

(here 1.65 is constant for 95% confidence)

= 0.5% - 1.65 × 1%

= -1.15% (Here negative sign depicts the loss)

Therefore,

maximum one-day loss in dollars

= maximum one-day percentage loss × Exchange rate × Amount to be received

= -1.15% × $1.01 × 5 million euros

= -0.0115 × 1.01 × 5,000,000

= -$58,075 (Here negative sign depicts the loss)