Chapter 10, The Foreign Exchange Market Video Solutions, Global Business Today

Problem 1

The interest rate on South Korean government securities with one-year maturity is 4 percent, and the expected inflation rate for the coming year is 2 percent. The interest rate on U.S. government securities with one-year maturity is 7 percent, and the expected rate of inflation is 5 percent. The current spot exchange rate for Korean won is $$\$ 1=$$ $\mathrm{W} 1,200$. Forecast the spot exchange rate one year from today. Explain the logic of your answer.

Akash M

Numerade Educator

Problem 2

Two countries, Great Britain and the United States, produce just one good: beef. Suppose the price of beef in the United States is $$\$ 2.80$$ per pound and in Britain it is $? 3.70$ per pound.
a. According to PPP theory, what should the dollar/pound spot exchange rate be?
b. Suppose the price of beef is expected to rise to $$\$ 3.10$$ in the United States and to $£ 4.65$ in Britain. What should the one-year forward dollar/pound exchange rate be?
c. Given your answers to parts $a$ and $b$, and given that the current interest rate in the United States is 10 percent, what would you expect the current interest rate to be in Britain?

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Problem 3

Reread the Management Focus on Embraer, then answer the following questions:
a. What does the recent economic history of Brazil tell you about the relationship between price inflation and exchange rates? What other factors might determine exchange rates for the Brazilian real?
b. Is a decline in value of the real against the U.S. dollar good for Embraer, bad for Embraer, or a mixed bag? Explain your answer.
c. What kind of foreign exchange rate risks is Embraer exposed to? Can Embraer reduce these risks? How?
d. Do you think Embraer's decision to try and hedge against further appreciation of the real in the early 2000 s was a good decision? What was the alternative?
e. Since 2008 , Embraer has significantly reduced its dollar hedging operations. Is this wise?
f. Between mid-2014 and early 2015 , the real depreciated significantly against the U.S. dollar. What do you think the impact was on Embraer?

Brandon Miskanic

Numerade Educator

Problem 4

You manufacture wine goblets. In mid-June, you receive an order for 10,000 goblets from Japan. Payment of $¥ 400,000$ is due in mid-December. You expect the yen to rise from its present rate of $$\$ 1=¥ 130$$ to $$\$ 1=¥ 100$$ by December. You can borrow yen at 6 percent a year. What should you do?

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Problem 5

You are the CFO of a U.S. firm whose wholly owned subsidiary in Mexico manufactures component parts for your U.S. assembly operations. The subsidiary has been financed by bank borrowings in the United States. One of your analysts told you that the Mexican peso is expected to depreciate by 30 percent against the dollar on the foreign exchange markets over the next year. What actions, if any, should you take?

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