A small Canadian company has contracted to purchase 100,000 toys for £ 3.50 each from a British company. The Canadians have agreed to pay in pounds ( £). The Canadians have also agreed to sell the toys to a U.S. company for U.S.$5.50 per toy. The Canadian company has agreed to accept U.S. dollars but plans to convert these revenues to Canadian dollars (C$). The Canadian company estimates its marginal costs (warehousing, travel, and so on) as C$.75 per toy.
Exchange rates at the time of signing the agreements are as follows:
Canadian $1 = U.S. $ 0.80
Canadian $1 = British pound £ 0.66
Show all of your calculations:
1. Is this a good deal for the Canadian company? Why or why not?
2. What impact would a devaluation of the U.S. dollar relative to the Canadian dollar have on the Canadian company's profits? What impact would a revaluation upward have? Use a specific example to illustrate your answer.
3. What impact would a devaluation of the British pound relative to the Canadian dollar have on the Canadian company's profits? What impact would a revaluation upward have? Use a specific example to illustrate your answer.
4. What could the Canadian company do to minimize its exchange rate risks?
Bonus:. What impact would a devaluation of the British pound relative to the U.S. dollar have on the Canadian company's profits? Use a specific example to illustrate your answer.