## Quiz 10 :The Foreign Exchange Market

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What are the risks associated with currency speculation?
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In international business there is always an exchange risk involved since there is more than one currency involved. There are ways to protect oneself against this risk. However one is chooses not to do so then the activity would go into the realm of currency speculation.
Currency speculation by its very definition is a risky business. Normally this would be done by using one currency to buy another with the hope that at a future date or time the currency that has been bought will appreciate so that when one converts back to the original currency, after paying the conversion cost for both transaction, one will make a profit. For instance if on buys $1000 using Indian Rupees (INR) when the rate is INR50=$1 and sells it when the rate it INR60 = $1 one would make a profit of INR10, 000 (ignoring transaction costs). However if the exchange rate remains below the buying rate of INR50=$1 then one will always make a loss.
This is the risk associated with currency speculation.

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The Australian dollar continued to rise by another 20 percent against the U.S. dollar in 2010 and 2011. How would this have affected Billabong? Is there anything that Billabong might have done to limit its long-term economic exposure to changes in the value of the currency in its largest export market?
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The continued rise of the Australian dollar in 2010 and 2011 would have caused more problems for Billabong as its exports became even more expensive for U.S. consumers. Many students will probably suggest that long-term, Billabong should consider moving production to the United States to decrease its exchange risk.

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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 the automaker's foreign currency exposure in 2003? What would have happened if it had hedged 70 percent of exposure? b. Why do you think the value of the U.S. 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.S. dollar against the euro?
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a) Volkswagen would have had to pay an expensive commission to hedge against the appreciation of the Euro. Also, if the Euro depreciated Volkswagen would lose a lot of profits if it hedged against appreciation. If Volkswagen had hedged 70%, it would have profited more that year.
b) The US dollar could have depreciated against the Euro for a number of reasons including higher relative inflation, increased demands for imports to the US, or lower interest rates in the US relative to the Euro. In 2002-2003 US inflation was slightly higher than in Europe and US consumers bought more imports by use of debt.
c) Volkswagen can shift production to the US so that the company's business is not as affected by the Euro-Dollar exchange rates.

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What is the relationship between interest rates and exchange rates?
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What is the relationship between price inflation and exchange rates?
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Why does a fall in the value of the Australian dollar against the U.S. dollar benefit Billabong?
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What might Billabong had done in order to better protect itself against the unanticipated rise in the value of the Australian dollar that occurred in 2009?
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What is the difference between a spot exchange rate and a forward rate?
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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 Korea won is $1 = W1,200. Forecast the spot exchange rate one year from today. Explain the logic of your answer. Essay Answer: Tags Choose question tag Why do businesses use forward exchange rates? Essay Answer: Tags Choose question tag Explain the difference between fundamental analysis and technical analysis with regard to exchange rate forecasting. Essay Answer: Tags Choose question tag What is a spot exchange rate? Essay Answer: Tags Choose question tag The Foreign Exchange Market Use the globalEDGE Resource Desk (http://globaledge.msu.edu/Reference-Desk) to complete the following exercises: You are assigned the duty of ensuring the availability of 10 billion Swiss francs for a payment scheduled for tomorrow. Your company possesses only U.S. dollars, so you must identify a website that provides real-time exchange rates and charts and find the spot exchange rate for Swiss francs. How many dollars do you have to spend to acquire the amount of francs required? Essay Answer: Tags Choose question tag Why would international businesses engage in countertrade? Essay Answer: Tags Choose question tag What are the main differences between the efficient market and inefficient market schools of exchange rate forecasting? Essay Answer: Tags Choose question tag If the government of a nation expands the domestic money supply, other things being equal, what will be the impact on price inflation in that country? Essay Answer: Tags Choose question tag Could the rise in the value of the Australian dollar that occurred in 2009 have been predicted? Essay Answer: Tags Choose question tag The Foreign Exchange Market Use the globalEDGE Resource Desk (http://globaledge.msu.edu/Reference-Desk) to complete the following exercises: Your company imports olive oil from Italy to sell in the United States. As expected, the exchange rate has changed from the previous year, which has affected your bottom line. In preparing an annual report for your company, you would like to include a one-year currency chart from a comprehensive currency website showing the quarterly movement of the U.S. dollar versus the euro. Download the relevant data indicating the exchange rate between these two currencies once per quarter for the past year. Then, analyze the data and describe the pattern you see. Over the past year, has the dollar gained or lost ground versus the euro? Essay Answer: Tags Choose question tag 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?