1. Using any website like the Wall Street Journal or the Economist.com, obtain quotes for foreign exchange rates for the Yen versus the US dollar, and answer the following questions (6 points)

a) What is the spot exchange rate for the US dollar vis-à-vis the yen?

b) Suppose one year ago, the spot exchange rate for the yen was ¥110/$. Comparing that to today’s quote, has the Japanese yen

*appreciated or depreciated*?

c) Suppose you export 100,000,000 (100 million) yen worth of goods to Japan today (what is that worth at Monday’s spot rate?) But your buyer will make the payment only 90 days from now. Suppose further that the buyer will make the payment in Japanese yen only.

Suppose the actual exchange rate for the yen, 90 days from now, turns out to be ¥110/$. How many dollars will you get 90 days from now?

Suppose the actual exchange rate for the yen, 90 days from now, turns out to be ¥130/$. How many dollars will you get 90 days from now?

Suppose you are like me, a conservative old man, who does not like this exchange rate uncertainty. Is there anything you could do to get rid of the uncertainty?

2. Two countries, Britain and the U.S. produce just one good, beef. Suppose that the price of beef in U.K. is £2.80 per pound, and in US, it is $3.70 per pound. (6 points)

(a) What should the $/£ spot exchange rate be, according to PPP theory?

(b) Suppose that the price of beef is expected to rise to £3.10 in the U.K. and to $4.65 in the US by the same time next year. What should the one year forward $/£ exchange rate?

(c) Given your answers to parts (a) and (b), and given that current interest rate in U.K. is 10%, what would you expect current U.S. interest rates to be?

3. You manufacture wine goblets. In mid-June, you receive and order for 10,000 goblets from Europe. Payment of €00,000 is due in mid-December. You expect the €ro to rise from its present rate of $1=€.5, to a rate of $1=€.4 by December. You can borrow €ros at 6% per annum and dollars at 15% per annum (assume that the rate at which you borrow is same as the rate you would receive if you invested in a bank account). What should you do if? (6 points)

(a) Scenario 1: the current 180-day forward rate is $1 = €.35

(b) Scenario 2: the current 180-day forward rate is $1 = €.45

4. Consider a Mexican firm that knits sweaters for sale to a U.S. department store. The firm incurs total costs of 16 pesos/sweater, and sells the sweaters to the department store for $5 per sweater. The exchange rate is 4 pesos/$.

a) What is the firm’s markup per sweater as a percentage of revenues? (1 point)

b) If the peso is devalued 20%, what is the new value of the peso? (1 point)

c) If the firm keeps dollar prices constant and peso costs constant, what is the markup per sweater as a percentage of revenue after the devaluation? (2 points)

d) If the firm decides to keep the gross margin per sweater constant (at 20%), would sales expand or decline? Why? What would the new dollar price be after devaluation? (2 points)

5. Suppose GM is considering buying a plant in Hungary. All sales will be to Hungarian customers and denominated in forints. The projected returns and investments are as follows:

Purchase price 30 billion forints

Additional investment $50 million, all imported from U.S.

Projected Hungarian sales 45 billion forints

Projected earnings 4.5 billion forints

Exchange rate 300 forints/$

a) What is the total investment in dollars? (1 point)

b) Once the plant is up and running, what is the annual percentage return on investment? (1 point)

c) If the forint is devalued 25%, what is the new exchange rate? (1 point)

d) If this 25% devaluation was made after the purchase and additional investment were completed, what is the new ROI? (1 point)

e) Instead of selling to the Hungarian market only, suppose all sales were exports, priced in hard currency, yielding the same 4.5 billion forints earnings (at the original 300 forints/$ exchange rate.) If the 25% devaluation now occurred, what would happen to the plant’s profit margins? (2 points)

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