3. Why exchange rates matter Suppose that you go on vacation to Canada every sum

Question

3. Why exchange rates matter Suppose that you go on vacation to Canada every summer. Last year, the hotel room where you stayed cost C$90 per night, and it costs the same this year. The exchange rate was 0.92 US$/C$ last year, and it is 1.01 US$/C$ this year. This means you will pay you paid last year per night this year than The U.S. dollar-Canadian dollar exchange rate is essentially the price of a Canadian dollar in terms of U.S. dollars. When this price rises, the Canadian dollar is said to appreciate against the U.S. dollar. Thus, from your analysis, you can conclude that when the Canadian dollar appreciates against the U.S. dollar, Canadian goods and services become expensive for Americans. DeutschAuto is a German automaker that pays most of its production costs in euros. Suppose that in 2005, DeutschAuto's cost of producing a car was 25,500 and that the company sold a car in the United States for $38,000. Further, suppose that the dollar-euro exchange rate rose from 1.15$/ in 2005 to 1.35$/ in 2007. DeutschAuto's euro cost of production did not change, and the company continued to charge $38,000 for its cars in the United States, as DeutschAuto believes this is its profit-maximizing price. Examine how the rise in the dollar-euro exchange rate affects DeutschAuto's profits from sales in the United States. (Hint: Ignore transportation costs.) In 2005, DeutschAuto's revenue from sales in the United States was DeutschAuto's profit was per car. Given the cost of production, this means that per car. In 2007, DeutschAuto's revenue from sales in the United States was DeutschAuto's profit was per car. Given the cost of production, this means that per car.

Explanation / Answer

1. Amount in USD paid earlier = 0.92 * 90 = $82.8
Amount paid now = 1.01 * 90 = $90.9
So you end up paying $8.10 more this year.

2. As the foreign currency appreciates against the home currency, you have to spend more units of USD to pay for the same amount of CAD.

3. Revenue in 2005: 38000/1.15 = EUR33,043
Profit in 2005: 33043 - 25500 = EUR7,543

Revenue in 2007: 38000/1.35 = EUR28,148
Profit in 2007: 28148-25500 = EUR2,648

4. It becomes more attractive/easier/less expensive for European companies to profit from exporting their products to the United States.

5. when USD/JPY = 104, assets are worth 600bn * 104 = 62.4 Trillion Yen
When USD/JPY = 90, assets are worth 600bn * 90 = 54 Trillion Yen

6. Holders of US securities in Japan experience a drop/reduction in their wealth

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