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Chapter 21

Q. 21.FSE.3

Minnesota Co. uses regression analysis to assess its economic exposure to fluctuations in the Canadian dollar, whereby the dependent variable is the monthly percentage change in its stock price, and the independent variable is the monthly percentage change in the Canadian dollar. The analysis estimated the intercept to be zero and the coefficient of the monthly percentage change in the Canadian dollar to be -0.6. Assume the interest rate in Canada is consistently higher than the interest rate in the United States. Assume that interest rate parity exists. You use the forward rate to forecast future exchange rates of the Canadian dollar. Do you think Minnesota’s stock price will be (a) favorably affected, (b) adversely affected, or (c) not affected by the expected movement in the Canadian dollar? Explain the logic behind your answer.

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Verified Solution

Minnesota’s stock price will be favorably affected. When the U.S. interest rate is higher, the forward rate of the Canadian dollar will exhibit a discount, which implies depreciation of the C$. The negative coefficient in the regression model suggests that the firm’s stock price will be inversely related to the forecast. Thus, the expected depreciation of the C$ will result in a higher stock price.