Effects of Intervention on Import Expenses
Hull Importing Company is a U.S.-based firm that imports small gift items and sells them to retail gift shops across the United States. About half of the value of Hull’s pur- chases comes from the United Kingdom, while the remaining purchases are from Mex- ico. The imported goods are denominated in the currency of the country where they are produced. Hull normally does not hedge its purchases.
In previous years, the Mexican peso and pound fluctuated substantially against the dollar (although not by the same degree). Hull’s expenses are directly tied to these cur- rency values because all of its products are imported. It has been successful because the imported gift items are unique and are attractive to U.S. consumers. However, Hull has been unable to pass on higher costs (due to a weaker dollar) to its consumers, because consumers would then switch to different gift items sold at other stores.
a. Hull expects that Mexico’s central bank will increase interest rates and that Mexico’s inflation will not be affected. Offer any insight on how the peso’s value may change and how Hull’s profits would be affected as a result.
b. Hull closely monitors government intervention by the Bank of England (the British central bank). Assume that the Bank of England intervenes to strengthen the pound’s value with respect to the dollar by 5 percent. Would this have a favorable or unfavorable effect on Hull’s business?