11.2 You have just received good news. You have a rich uncle in France who has d
ID: 2449410 • Letter: 1
Question
11.2 You have just received good news. You have a rich uncle in France who has decided to give you a monthly annuity of €2,000 per month. You are concerned that you will become accustomed to having these funds, but if the currency exchange rate moves against you, you may have to make do with less.
A. If you are living in Canada, what does it mean for the currency exchange rate to move against you?
B. Would moving to France mitigate some of the risk? If so, how? If not, why not?
C. If you want to stay in Canada, and your grandparents, who have retired to Provence, receive a Canadian pension of C$1100 each, what could you do to reduce the risk for all of you?
Explanation / Answer
A. Curreny exchange rate moving against me : this means that the euro has appreciated in value against the canadian dollar. Assuming the fact that i am living in Canada, and i recieve the money in the euro, then, if the euro appreciates against the canadian dollar, this means that i would get a less amount of canadian dollar against the 2000 euro that i recieve from my uncle.
B. Moving onto France reduces the exchange rate risk, which i was facing staying back in Canada, because i dont need to exchange the euro with canadian dollar, which is exposed to exchange rate risk.
However moving to France, also has its own shortcomings, like the annual inflation rate, which if rises actually eats the purchasing power of the fixed 2000 euro that i receive from my uncle every month. This actually means that if the inflation rate goes up in France, then my purchasing power gets reduced, ie i would be able to buy lesser amount of the good with the fixed 2000 euro that i receive from my uncle.
C. If i am staying in Canada, with my grandparents, who get total pension amount of Canadian dollar of 2200 ie C$1100 each plus my 2000 euro earning from my uncle is the total amount that i have. In this case, the only risk that lies is the exchange rate risk for the euro that i recieve from my uncle. In order to mitigate that risk, i can resort to entering in to a forward contract with a bank in order to lock in the exchange rate for the euro against the canadian dollar. By doing this i can insure myself against the exchange rate fluctations that might take place.
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