Given the following Euro to $ Exchange rate of 1.46, what is the information con
ID: 2640257 • Letter: G
Question
Given the following Euro to $ Exchange rate of 1.46, what is the information contained in this quote? If the Purchasing Power Parity Theory is correct, what is true about the relationship between the US dollar and the Euro at this exchange rate?
Identify and describe the ways in which a US company can participate in international commerce.
The price of a currency forward contract is determined by the relationship between interest rates of the two countries in question and the time period covered by the contract. Is this statement exactly true, partly true or false. Explain your response.
Company ABC commits to sell $10 million of its product (produced in the US with raw materials from the US) to a Japanese customer delivered within 60 days from today with payment to be received 90 days from today in yen. What are the risks faced by ABC? What are the events in the currency markets which would erode the profitability of this sale? How can ABC protect itself from the adverse consequences of currency market fluctuations?
Citibank US plans to lend $100 million US to a Canadian customer. The borrower will repay the loan in Canadian dollars. Describe in some detail how the risks of this loan differ from those of lending $10 million in the US. What are the ways that a US bank can manage the risks of lending in Canada.
Explanation / Answer
Answer to part (a):
Given Exchange Rate : Euro to $ = 1.46
it can also be written as : Euro/$ = 1.46
and again simplifying, it means 1$ = 1.46 Euro.
This implies that $ currency is quite more strong currency as compared to Euro. It also implies that for getting 1$, you need to spend 1.46 Euro and for getting 1 Euro, you will spend only 0.68$. So, $ is strong currency than Euro.
If the Purchasing Power Parity Theory is correct at this Exchange Rate, it will imply that a commodity which is being sold for 1.46 Euro in England is being sold for 1$ in America, keeping other factors constant.
Answer to Part (b) :
There are many ways in which a US comp. can participate in International Commerce some of which are Currency Market,Share Market, Commodity Market, Hedging etc.
Answer to Part (c) :
The given statement regarding determination of Currency Forward Contract Price is Exactly True. The Reason being the application of Interest Rate Parity Theory(IRPT) which also says that the Forward Rate will be determined by Interest Rates of both the countries.The Role of Time Period is that As late as you delay the contract, it will be higly exposed to fluctuations and uncertainites associated with the Exchange rates. So, Forward Exchange Rate also depend upon the period of contract.
Answer to Part(d) :
The US Comp. will procure Raw Materials from US and then sell the product to japanese customer in 60 days who will give the payment in 90 days and that also in YEN.
The Major Risks faced by ABC are:
1.Non-Availability of Cash for a period of 90 days and after 90 days also, it is not sure to get payment.
2.The Major Risk is of Downfall of Yen as compared to $, because in that case the US Comp. will receive Less payment than $10 Million, that means its anticiapted profits will be mugged up by Currency fluctuation.
3.It will have to follow Laws and Rules relating to Forex transactions and will have to face its associated Risks.
The Major Event in the Currency Market which will erode the Profitability of this Sale is Downfall of YEN as compared to US$ because in that case, the US Comp. will receive Less payment than $10 Million.
The ways in which ABC can protect itself are:
1.Forward Cover under which it can enter into Forward Contract with a Bank to sell YEN and get $ at a pre-contracted Rate.
2. HEDGING under which it can enter into a similar Currency contract in which it will sell YEN obtained form Japanese Customer and will obtain $.
Answer to Part(e) :
If CitiBank lends $100 Million to a Canadian Customer who will repay the Loan in Canadian Dollars, then Bank will be Highly Exposed to the Risk of Fluctuations in Currency Market. If on the date of Repayment, Rate of Canadian Dollars falls or say Rate of Dollar Rises, then Citi Bank will receive Less than $100 Million after all Conversions. Whereas all these Risks will not be there in case of Lending to US Citizen, since no Conversions will have to be done and no Risk of Downfall of Canadian $.
The ways in which US Bank can manage to mitigate this Risk are :
1. Enter into a Forward Cover under which Bank will sell Canadian Dollars at some Pre-Contracted Rate and in turn will Receive $100 Million.
2. Enter into HEDGING Contract under which US Bank will sell all Canadian Dollars Received and get Dollars in Return.
3. Borrow such amount in Canadian Dollars such that after Lending period is over, Bank receive Canadian Dollars from Canadian Customer and Repay the debt and from Canadian Dollars borrowed today, convert it into US $ and Invest in US.
Thanx.
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