Module 9 Assignment

Module 9: Critical Thinking Assignment
Jessica R. Turner
The University of Alabama at Birmingham
MG415: International Business Dynamics
Professor Sahra Mohamadian
March 28, 2021

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 $1 = W1,200.
Forecast the spot exchange rate one year from today. Explain the logic of your answer.
- According to the Fisher effect, the real interest rates for the US and South Korea are 2%
(4-2 = 2 ; 7-5 = 2). Using the formula [(S1 - S2)/S2] x 100 = i$ - iW, with S1 being 1200,
i$ being 7, and iW being 4, the value for S2 is $1=W1165.
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?
- $2.80/£3.70 = $0.76 per £1
OR
£3.70/$2.80 = £1.32 per $1
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?
- $3.10/£4.65 = $0.67 per £1
OR
£4.65/$3.10 = £1.50 per $ 1
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?
- [(S1 - S2)/S2] x 100 = i$ - i£
[(1.32 - 1.50)/1.50] x 100 = 10 - i£
[(1.32 - 1.50)/1.50] x 100 = 10 - (-12)
[(1.32 - 1.50)/1.50] x 100 = 22%
3. Reread the Management Focus “Embraer and the Gyrations of the Brazilian Real,” and
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?
- When inflation in Brazil rises, the currency weakens, which changes exchange
rates between currencies. Monetary policies and interest rates can also
determine the 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.
- The decline of the real against the U.S. dollar was a mixed bag for Embraer. One
thing that is positive about the weakening of the real against the U.S. dollar is the
fact that Embraer’s products are priced in U.S. dollars. The decline in value of the
real means that the sale of these products in U.S. dollars will result in a higher
profit margin. However, Embraer also buys the materials for their products in
U.S. dollars. If the real is weaker than the U.S. dollar, this makes purchasing
materials much more expensive for the company.
c. What kind of foreign exchange rate risks is Embraer exposed to? Can Embraer
reduce these risks? How?
- Embraer is exposed to transaction risks because they sell their products and buy
materials in US dollars. During the time it takes to exchange the currency,
exchange rates could change. The fact that they sell products and buy materials
in US dollars also exposes the company to translation risks because the
exchange rates can impact financial statements. Embraer can reduce these two
risks by using forward exchange rate contracts or exchange rate swaps. Lastly,
the fact that the company operates with both the US dollar and Real, it is
exposed to economic risks because the strength of the currencies depend on the
economic situation in the countries. Embraer could reduce this risk by expanding
its customer base so that the risk is not so concentrated on the US dollar and
Real.
d. Do you think Embraer’s decision to try to hedge against further appreciation of

the real in the early 2000s was a good decision? What was the alternative?
- Hedging would have been a good decision for Embraer had the economic crisis
of 2008 not occurred because they could have locked in the rate at which sales
made in dollars were exchanged to reals. However, the real did not continue to
appreciate, it depreciated against the dollar. Because it had locked into a high
real/dollar exchange rate, this caused the company to lose hundreds of millions
of dollars. Had the company not decided to hedge against the appreciation of the
real (though this would have been a bad decision if the real had continued to
appreciate), the company would not have been locked into the high exchange
rate.
e. Since 2008, Embraer has significantly reduced its dollar hedging operations. Is
this wise?
- Reducing dollar hedging operations has made Embraer’s sales revenues
sensitive to the dollar exchange rate, resulting in the appreciation of Real
pressuring Embraer’s revenues. However, this has ultimately been a good thing
for Embraer due to the stagnation of Brazil’s economy and rising inflation which
resulted in the decline in value of the real. Because of this, Embraer’s stock price
surged.
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?
- Similar to in 2017 when the real depreciated by 50% against the US dollar, I think
this probably didn’t have a very negative effect if investors viewed this as a
potential for Embraer’s revenues to boost when converted from US dollars to
reals.
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?
- I should wait until December and accept the ¥400,000 payment, because in December
the yen will have risen to be worth more to the dollar at $1 = ¥100 rather than $1 = ¥130.
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?
- Because the peso is expected to depreciate against the dollar, I would need to reduce
spending on these parts (reducing my inventory) for now and increase it once the peso
depreciates. This will save the firm money by reducing costs on inventory.

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How does the Fisher effect relate real interest rates and exchange rates?

What factors can impact the exchange rate of a currency?

Module 9: Critical Thinking Assignment

The University of Alabama at Birmingham

MG415: International Business Dynamics

Professor Sahra Mohamadian

March 28, 2021

[(1.32 - 1.50)/1.50] x 100 = 10 - i£

[(1.32 - 1.50)/1.50] x 100 = 10 - (-12)

[(1.32 - 1.50)/1.50] x 100 = 22%

d. Do you think Embraer’s decision to try to hedge against further appreciation of

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