Deck 9: Regional Economic Integration

Question 1

In retrospect, could the fall in the value of the dollar against the euro have been predicted in 2003?

Answer 1

Between 2003 and 2006, the value of Euro increased in comparison with the US Dollar attributing to several reasons. This affected the operations of several companies where USD was used predominantly as a currency to measure sales. This leads to the discussion whether the fall in dollar value could have been predicted in 2003. Euro was reported to be volatile against the USD. There was a gradual increase observed from the end of 2000 trading at €1=$0.83 in October 2000. The Euro and USD reached parity where €1=$1 in the late 2002. Though the predictions were for a rapid rise in the value of Euro, the increase was very slower reaching €1=$1.20 by the end of 2003. There was a steady increase reaching €1=$1.32 in 2005 and dropping back to €1=$1.20 in early 2006 and rising again to €1=$1.30 by the late 2006. Between 2003 and 2006, the value of Euro increased gradually as against USD. It would be easier for experts to predict from other indicators which were negatively affected in the US. As the US was increasingly dependent on the imports, it encountered trade deficits as exports were lower. This means that there was an increase cash outflow of USD to other foreign countries. These foreigners sold USD for other currencies due to their pessimistic view undervaluing the USD. Their views were based on the US plan to maintain a weak dollar to boost exports and the reported higher budget deficits of the country. The US was expected to increase the supply of dollar which may cause inflation and further reduce dollar value. As these trends were explicitly known, it would have been easier to predict the rise of Euro value against the USD.

Question 2

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..government securities with one-year maturity is 7 percent and the expected rate of inflation is 5 percent.The current spot exchange rate for Korea won is $1 = W1,200.Forecast the spot exchange rate one year from today.Explain the logic of your answer.

Answer 2

From the Fisher effect, we know that the real interest rate in both the US and South Korea is 2%.  The international Fisher effect suggests that the exchange rate will change in an equal amount but opposite direction to the difference in nominal interest rates.  Hence since the nominal interest rate is 3% higher in the US than in South Korea, the dollar should depreciate by 3% relative to the South Korean Won.  Using the formula from the book:  (S 1 - S 2 )S 2 x 100 = i $ - i Won   and substituting 7 for i $ , 4 for i Won , and 1200 for S 1, yields a value for S 2 of $1=W1165.

Question 3

Use the globalEDGE Resource Desk (http://globalEDGE.su.du/ResourceDesk/)to completethe following exercises:
You are assigned the duty of ensuring the availability of 100 million Japanese Yen for a payment scheduled for tomorrow.Your company possesses only US Dollars, so identify a website that provides real-time exchange rates , and find the spot exchange rate for Japanese Yen.How many dollars do you have to spend to acquire the amount of Yen required?

Answer 3

The currency exchange rates can be accessed via a variety of sources.  A list of these sources is available http://globaledge.msu.edu/ResourceDesk/ and can be accessed by searching the term "real-time exchange rates". One resource listed under this search is the FX Street, located under the globalEDGE category "Money: Finance".  This site offers daily updated information about foreign exchange markets as forex news, market reports, forecasts, and real-time exchange rates and charts. A currency converter and historical tables are also available. Search Phrase: "Real-time Exchange Rates" Resource Name: FX Street Website: http://www.fxstreet.com globalEDGE Category: "Money: Finance"

Question 4

What was the fundamental reason for the decline in the value of the dollar against the euro in 2003-2006? To what extent is the decline in the value of the dollar consistent with the theories of exchange rate determination discussed in this chapter?

Question 5

Two countries, Britain and the US produce just one good: beef.Suppose that the price of beef in the US is $2.0 per pound, and in Britain it is £3.0 per pound.a)According to PPP theory, what should the $/£ spot exchange rate be?
(b)Suppose the price of beef is expected to rise to $3.0 in the US, and to £4.5
in Britain.What should be the one year forward $/£ exchange rate?
(c)Given your answers to parts (a)and (b) and given that the current interest rate in the
US is 10 percent, what would you expect current interest rate to be in Britain?

Question 6

Use the globalEDGE Resource Desk (http://globalEDGE.su.du/ResourceDesk/)to completethe following exercises:
Your company imports olive oil from Italy to sell in the U..The exchange rate fluctuations over the past year have had significant impact on your bottom line.In preparing an annual report for your company, you would like to include a one-year currency chart showing the movement of the U..Dollar versus the Euro.Describe the pattern you see.Over the past year, has the Dollar gained or lost ground versus the Euro?

Question 7

Why do you think that STMicro did very little currency hedging? Was this wise?

Question 8

Reread the Management Focus feature on Volkswagen in this chapter, then answer the following questions:
a)Why do you think management at Volkswagen decided to hedge only 30 percent of their foreign currency exposure in 2003? What would have happened if they had hedged 70 percent of their exposure?
b)Why do you think the value of the U..dollar declined against that of the Euro in 2003?
c)Apart from hedging through the foreign exchange market, what else can Volkswagen do to reduce its exposure to future declines in the value of the U..dollar against the euro?

Question 9

What strategy is STMicro now adopting to deal with possible future fluctuations in exchange rates? Is this a smart strategy?

Question 10

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% per annum.What should you do?

Question 11

You are CFO of a U..firm whose wholly owned subsidiary in Mexico manufactures component parts for your U..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?