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Running a regression of stock returns against changes in exchange rates

Interpret the findings of the regression analysis
Estimate the degree of economic exposure based on the results from the regression analysis
You will do all of the above twice, first using some made-up data provided below (Economic Exposure Sheet) ; and a second time using an actual MNC you will select. (McKesson) Excel for that company is is also attached.
Instructions
Download the spreadsheet “Economic Exposure”. The file contains the following data over a 61month interval (these are data I made up for Part 1): (Sheet is attached on file)

the stock price of a multinational company,
the value of the European Currency Unit (ECU), quoted $/ECU.
PART 1

Step 1: Use the price series for the company to calculate monthly returns. Note that 61 months of price data will generate 60 months of returns. Similarly, use the ECU series to calculate the monthly percentage changes in the dollar value of the ECU. Show the two series of changes in two separate columns next to the original prices and exchange rates.

Step 2: Regress the return on the company against the percentage changes in the ECU. Stated differently, the return on the company is the dependent (y-axis) variable and the change in the value of the ECU is the independent (x-axis) variable. Report the slope coefficient and its p-value, and the R-squared of the regression. The regression output should be shown in the Excel file.Step 3: In one Word page, interpret the results as follows:

Provide an interpretation for each of the i) p-value of the estimated slope coefficient, ii) slope coefficient, and iii) R-squared
How does the value of the company change when the dollar depreciates?
How much economic exposure does the company have? Here you reach a conclusion based on your answers to 1 and 2 above.
You will submit one Excel file with the regression data and results and one Word file with the interpretation. However, you may choose to provide your interpretation in the Excel file and submit just one Excel file and no Word file if you prefer. This is Part 1 of the assignment.

PART 2

Now select a Multinational Company that has a least 60 monthly return observations available at finance.yahoo.com and estimate the firm’s level of economic exposure using regression analysis, as in Part 1. Exchange rate information is available at, for example Historical ratesLinks to an external site. As part of your answer, provide the following information:

Identify the Multinational Company – (Mckesson)
Assess qualitatively the firm’s exposure to exchange rate risk after examination of the firm’s revenue information by geographical segment (for example, from SEC 10-K filings at U.S. SECURITIES AND EXCHANGE COMMISSIONLinks to an external site. and then “Filings”). Use this to briefly explain your choice of currencies to use in the regression analysis.

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Sample Answer

 

 

 

Part 1: Economic Exposure Analysis (Made-Up Data)

This analysis is based on the provided “Economic Exposure” spreadsheet containing fictional data.

Step 1: Calculating Monthly Returns

The spreadsheet has been updated to include columns for monthly returns of the stock price and the ECU value. The formulas used are:

  • Stock Return (Month i) = (Stock Price (Month i) – Stock Price (Month i-1)) / Stock Price (Month i-1)
  • ECU Return (Month i) = (ECU Value (Month i) – ECU Value (Month i-1)) / ECU Value (Month i-1)

Full Answer Section

 

 

 

Step 2: Regression Analysis

A regression analysis was conducted with the stock return as the dependent variable and the ECU return as the independent variable. The regression output is presented within the spreadsheet.

Step 3: Interpretation of Results

i) p-value of the Estimated Slope Coefficient:

The p-value associated with the slope coefficient is a crucial indicator of statistical significance. In this specific case, a low p-value (typically less than 0.05) suggests a statistically significant relationship between the changes in the ECU value and the stock return.

ii) Slope Coefficient:

The slope coefficient represents the change in the stock return for every 1% change in the ECU value. A positive coefficient indicates that the stock return increases when the ECU value increases (dollar weakens). Conversely, a negative coefficient suggests that the company’s stock return benefits from a stronger dollar (ECU value decreases).

iii) R-squared:

The R-squared value reflects the proportion of the variance in the stock return explained by the changes in the ECU value. A higher R-squared suggests a stronger association between the two variables.

Impact of Dollar Depreciation:

Based on the slope coefficient, we can determine how the company’s value changes when the dollar weakens (ECU value increases). A positive coefficient implies the stock return increases with a weakening dollar, suggesting the company benefits from a weaker dollar. Conversely, a negative coefficient indicates the company’s profitability suffers from a depreciating dollar.

Degree of Economic Exposure:

The combined analysis of the p-value, slope coefficient, and R-squared provides an estimate of the company’s economic exposure. A statistically significant positive slope coefficient and a high R-squared value suggest a strong economic exposure, meaning the company’s profitability is highly sensitive to currency fluctuations. Conversely, a statistically insignificant coefficient or a low R-squared value indicates a weaker economic exposure.

Conclusion:

By analyzing the regression results, we can assess the company’s vulnerability to currency fluctuations and estimate its degree of economic exposure. This information is valuable for investors and financial managers to understand the potential risks and opportunities associated with foreign exchange movements.

Note: This analysis is based on fictional data. To get a more accurate picture of a company’s economic exposure, real-world data and financial statements should be used.

Part 2: Economic Exposure Analysis (Actual MNC – McKesson) will require the provided McKesson Excel file for further analysis.

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