Estimating Foreign Exchange Exposure in the Department of National Defence


  1. Desmier, P.E.
Corporate Authors
Defence R&D Canada - Centre for Operational Research and Analysis, Ottawa ON (CAN);Directorate Materiel Group Operational Research, Ottawa Ont (CAN)
Quantifying foreign exchange risk is not a trivial process although it is generally accepted that the standard method for reporting financial risk today is the “Value-at-Risk” or VaR method. Simply put, VaR is defined as the predicted worst-case loss at a specific confidence level over a certain period of time. Thus VaR provides a quantitative measure of the downside risk of exposure in all foreign currency transactions. This report documents the theory and application of a model that is built on forecasting expenditures for the ADM(Mat) National Procurement and Capital (equipment) accounts and the time-varying volatilities of foreign currency returns. These diverse methodologies are then combined into an overall VaR model to determine the maximum expected loss from adverse exchange rate fluctuations over the budget year. This is recognized as the first step any organization must take before considering risk mitigation strategies to reduce and hopefully eliminate foreign transaction exposure. This study also illuminates certain policy implications for functional finance and performance/ risk management specialists in the department. In particular, the VCDS Group through the Director Force Planning and Programme Coordination (DFPPC), and ADM(Fin CS) through Director Budget and Director Strategic Finance and Costing (DSFC), may want to examine the possibility of adjusting corporate budget allocations (quarterly) based on the results of the VaR model. The department should a

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Strategic Finance;AICC;Akaike’s Information Criterion;ARMA;Autocorrelation Function;Autoregressive;FHS;Filtered Historical Simulation;Foreign Exchange Exposure;FOREX;GARCH;Generalized Autoregressive Conditional Heteroskedastic;Interactive Time Series Modelling;ITSM;Maximum Likelihood Estimation;MLE;Moving Average;National Procurement;Quantile-Quantile Plots;Time Series;Value at Risk;VaR
Report Number
DRDC-CORA-TR-2006-23 — Technical Report
Date of publication
01 Jan 2007
Number of Pages
Electronic Document(PDF)

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