Problem 1. a. Curtis, Inc., is the leading beer in Patagonia, with a 65% share of the market. Because of trade barriers, it faces essentially no import competition. Exports account for less than 2% of sales. Although some of its raw material is bought overseas, the large majority of the value added is provided by locally supplied goods and services. Over the past five years, Patagonian prices have risen by 300%, while U.S. prices have risen by about 10%. During this time period, the value of the Patagonian peso has dropped from P1 = $1.00 to P1 = $0.50.
I. What has happened to the real value of the peso over the past five years? Has it gone up or down?
II. What has the high inflation over the past five years likely done to Curtis's peso profits? Explain.
III. Curtis has applied for a dollar loan to finance its expansion. Were you to look solely at its past financial statements in judging its creditworthiness, what would be your likely response to Curtis's dollar loan request?
IV. What foreign exchange risk would such a dollar loan face? Explain.
b. Suppose, we are given the following information:
Nominal Interest Rates in United States = 4%
Nominal Interest Rates in Germany = 6%
Current Exchange Rate: €1 = $2
I. Which currency should appreciate and which currency should decline?
II. By how much foreign currency (euro) will change?
III. What will be the anticipated value of euro in one year given the nominal interest rates as per International Fisher Effect (IFE)?
IV. Suppose, the exchange rate is fixed and does not change, which currency will appreciate or depreciate in real terms? Which country will attract investment?
Problem 2.
a. Define a currency forward, futures, and option contract.
b. When a forward market already existed, why was it necessary to establish currency futures and currency options contracts? Give five reasons.
c. Assume that Alfred Company, Inc. expects to pay Euro500, 000 in one year. The existing spot rate of the euro is $0.60. The one-year forward rate of the Euro is $0.63.
A one-year put option on euro is available with an exercise price of $0.63 and a premium of $0.03 per unit. A one-year call option is available on euro with an exercise price of $0.63 with a premium of $0.04 per unit.
I. Are you facing foreign currency exposure due to the appreciation or depreciation of dollar?
II. How would you hedge your exposure with forward contracts and option contracts?
III. What will be the dollar cost of hedging with forward contract?
IV. What will be dollar cost of hedging with options?
V. Which one would you choose and why?
Problem 3.
a. Can a firm face economic exposure, but no transaction exposure? Provide detailed example. (Minimum 200 words)
b. Nissan Motor Company exports cars to the United States (invoiced in Japanese yen) and competes against other companies. If purchasing power parity exists, how a strong yen may impact Nissan, Inc.?
c. Airbus Industrie, the European consortium of aircraft manufacturers, buys jet engines from U.S. companies. According to a recent story in the Wall Street Journal, "as a result of the weaker dollar, the cost of a major component (jet engines) is declining for Boeing's biggest competitor." The implication is that the lower price of engines for Airbus gives it a competitive advantage over Boeing. Will Airbus now be more competitive relative to Boeing? Explain. (minimum 200 words)
Problem 4.
a. Suppose that three-month interest rates (annualized) in Japan and the United States are 7% and 9%, respectively. The spot rate is ¥142/$1 and the 90-day forward rate is ¥139/$1.
I. Where would you invest?
II. Where would you borrow?
III. What arbitrage opportunities do these figures present?
IV. Assuming no transaction costs, what would be your arbitrage profit per dollar or dollar-equivalent borrowed?
b. Assume that Nissan spends an average of 1.875 million yen to manufacture a car in Japan, plus $2,600 to market and distribute the car in the United States. Furthermore, Nissan adds 10% margin to price the car. The exchange rate is $1 = ¥100
I. Assuming that the exchange rate at the end of the year is expected to be $1 = ¥80, what will be the impact of the exchange rate on the dollar cost the auto?
II. If Nissan had wanted to sell the car at the same price at which they were selling earlier, by how much would it have to cut costs, given the exchange rate in part a above.
III. If the same car were manufactured in the United States at a cost of $19,000 and 40 percent of parts were imported from Japan, what impact would the different exchange rates have on the dollar cost?
IV. Suggest some strategies that can be used by Nissan to counter strong yen.
V. Suggest some strategies that can be used by Nissan in a weak yen environment.
VI. Suppose $1 = ¥125. The U.S. inflation rate is 2% and Japanese inflation rate is 4%. The exchange rate is fixed. What happens to the competitiveness of Japanese companies versus United States? Explain clearly.
Please be strict to the examiner instructions as follows
Notes:
- All your responses must be typewritten
- Answer to each subpart must be a minimum of 100 words
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