Running a regression of stock returns against changes in exchange rates
Analyzing Economic Exposure: Part 1 (Made-up Data)
Following the instructions, let's analyze the economic exposure of the multinational company based on the provided data:
Step 1: Calculating Monthly Returns
We need to calculate the monthly returns for both the company's stock price and the ECU value. Here's the formula for calculating monthly returns (assuming data starts in cell A1):
= ((B2-B1)/B1)*100
a) Stock Return: Insert this formula in cell C2 (next to the price in cell B2) and copy it down for all subsequent months (60 months in total). This will give you the monthly percentage change in the stock price.
b) ECU Return: Use the same formula in cell D2 (next to the ECU value in cell C2) and copy it down for all months. This will give you the monthly percentage change in the ECU value (remember, a positive value indicates a depreciation of the dollar).
Step 2: Regression Analysis
Perform a linear regression in Excel with the following setup:
- Dependent Variable (Y-axis): Stock Return (values in column C)
- Independent Variable (X-axis): ECU Return (values in column D)
Run the regression analysis and record the following results:
- Slope Coefficient: This value represents the change in the company's stock return for every 1% change in the ECU value (positive or negative).
- P-value of the Slope Coefficient: This value indicates the statistical significance of the slope coefficient. A low p-value (typically less than 0.05) suggests a statistically significant relationship between the variables.
- R-squared: This value represents the proportion of the variance in the company's stock return explained by the changes in the ECU value.
Step 3: Interpreting the Results (Write this in a separate Word document)
i) P-value:
- A low p-value (e.g., less than 0.05) suggests a statistically significant relationship between the company's stock return and the ECU value. This means that changes in the ECU value are likely influencing the company's stock performance.
- A high p-value (e.g., greater than 0.05) indicates a statistically insignificant relationship. In this case, ECU fluctuations might not be a significant factor affecting the company's stock return.
ii) Slope Coefficient:
- A positive slope coefficient indicates that the company's stock return tends to move in the same direction as the ECU value. In other words, a depreciation of the dollar (positive ECU return) might lead to an increase in the company's stock price (positive stock return).
- A negative slope coefficient suggests the opposite. The company's stock return might move against the ECU value. A depreciation of the dollar could lead to a decrease in the company's stock price.
iii) R-squared:
- A high R-squared value (closer to 1) indicates that changes in the ECU value explain a large portion of the variations in the company's stock return. This suggests high economic exposure, meaning the company's financial performance is significantly impacted by currency fluctuations.
- A low R-squared value (closer to 0) suggests that ECU fluctuations have a minimal impact on the company's stock return. This indicates low economic exposure.
Company's Value Change with Dollar Depreciation:
Based on the slope coefficient, you can determine how the company's value changes when the dollar depreciates (ECU value increases).
- A positive slope coefficient signifies that the company's value tends to increase with a depreciation of the dollar.
- A negative slope coefficient suggests the company's value might decrease with a depreciation of the dollar.
Economic Exposure:
The combined interpretation of the p-value, slope coefficient, and R-squared will help you estimate the degree of economic exposure.
- A statistically significant positive relationship (low p-value, positive slope) with a high R-squared value indicates high economic exposure. The company's performance is heavily influenced by currency fluctuations.
- A statistically insignificant relationship (high p-value) or a low R-squared value suggests low economic exposure. Currency fluctuations have a minimal impact on the company's performance.
Note: This analysis provides a starting point for understanding economic exposure. You'll need to perform the calculations and interpret the results based on the specific data in the "Economic_Exposure.xls" file.
Next Steps:
Repeat steps 1-3 using real data from a chosen Multinational Company (MNC). This will allow you to assess the actual economic exposure of that specific company.