Problem Set 2 International Finance Shrikhande Fall 2006 SUGGESTED SOLUTIONS TO C !

PTE" # P"O$LE%S
1. From base price levels of 100 in 1987, West German and U.S. price levels in 1988 stood at 102 and 106, respectivel . !f t"e 1987 #$%& e'c"an(e rate )as #0.*+, )"at s"o,ld t"e e'c"an(e rate be in 1988- !n fact, t"e e'c"an(e rate in 1988 )as %& 1 . #0.*6. W"at mi("t acco,nt for t"e discrepanc /0rice levels )ere meas,red ,sin( t"e cons,mer price inde'.1

!NS&E"' !f e1981 is t"e dollar val,e of t"e German mar2 in 1988, t"en accordin( to p,rc"asin( po)er
parit e1988$.*+ . 106$102 or e1988 . #.*612. 3"e discrepanc bet)een t"e predicted rate of #.*612 and t"e act,al rate of #.*6 is insi(nificant and "ence needs no e'plainin(. 4istoricall , "o)ever, discrepancies bet)eent"e 000 rate and t"e act,al rate "ave fre5,entl occ,rred. 3"ese discrepancies co,ld be d,e to mismeas,rement of t"e relevant price indices. 6stimates based on narro)er price indices reflectin( onl traded (oods prices )o,ld probabl be closer to t"e mar2, so to spea2. 7lternativel , it co,ld be d,e to a s)itc" in investors8 preferences from dollar to non9dollar assets. :. !n earl 1996, t"e s"ort9term interest rate in France )as :.7;, and forecast Frenc" inflation )as 1.8;. 7t t"e same time, t"e s"ort9term German interest rate )as 2.6; and forecast German inflation )as 1.6;. a. <ased on t"ese fi(,res, )"at )ere t"e real interest rates in France and German -

!NS&E"' 3"e Frenc" real interest rate )as 1.0:7$1.018 9 1 . 1.87;. 3"e correspondin( real rate in
German )as 1.026$1.016 9 1 . 0.98;. b. 3o )"at )o,ld o, attrib,te an discrepanc in real rates bet)een France and German -

!NS&E"' 3"e most li2el reason for t"e discrepanc is t"e incl,sion of a "i("er inflation ris2
component in t"e Frenc" real interest rate t"an in t"e German real rate. =t"er possibilities are t"e effects of c,rrenc ris2 or transactions costs precl,din( t"is seemin( arbitra(e opport,nit . +. !n >,l , t"e one9 ear interest rate is 12; on <ritis" po,nds and 9; on U.S. dollars. a. !f t"e c,rrent e'c"an(e rate is #1.6:?,1, )"at is t"e e'pected f,t,re e'c"an(e rate in one ear-

!NS&E"' 7ccordin( to t"e international Fis"er effect, t"e spot e'c"an(e rate e'pected in one ear
e5,als 1.6: ' 1.09$1.12 . #1.*86:. b.S,ppose a c"an(e in e'pectations re(ardin( f,t,re U.S. inflation ca,ses t"e e'pected f,t,re spot rate to decline to #1.*2?£1. W"at s"o,ld "appen to t"e U.S. interest rate-

!NS&E"' !f r,s is t"e ,n2no)n U.S. interest rate, and ass,min( t"at t"e <ritis" interest rate sta ed at
12; /beca,se t"ere "as been no c"an(e in e'pectations of <ritis" inflation1, t"en accordin( to t"e !F6, 1.*2$1.6: . /1@r,s1$1.12 or r,s . +.++;.

7t t"e same time.6'plain. SF12.ro a(ainst t"e po. t"e dollar spot rate in one ear s"o. )"at )ill t"e nominal interest rate be accordin( to t"e Fis"er effect- !NS&E"' 7ccordin( to t"e Fis"er effect. #0.tin( in t"e n. t"e relations"ip bet)een t"e nominal interest rate. /1 @ a1/1 @ i1. 9 :.::::1 9 .7867 to repa t"e principal pl.06$1. dollar cost of borro)in( francs for t"e ear- !NS&E"' %. on t"e 6. it cost onl #0. @ *.. 110.101$. t"e e5.0* ' 2 . /12.nd )ill be sellin( relative to t"e Frenc" franc- !NS&E"' <ased on t"e n. U.nt1 at )"ic" t"e po. t"e po.07 ' 1.ired ret.ld e5. t"e e'c"an(e rate c"an(es from FF 1 . t"e e'pected inflation rate in France is 12. 12.. Wit" U.min( t"at arbitra(e )ill e5.1. in 6n(land.1* on >an. SF 12. 921.s interest. &ean)"ile. !f e'pected inflation is 100.nit .me t"e interest rate is 16.06$1. )e can calc. and a 10.7. a.121 . ass.rrent spot rate is £1 . t"e real dollar cost of repa in( t"e principal and interest is #0.m of 10. !f t"e c.2*08 or a real dollar interest rate of 92*.* ' /1.:::: . and 12. is t"ere an arbitra(e opport. 10. S.99. or r .:2.btractin( t"e ori(inal #1 borro)ed. S.S.m po.mbers in t"e problem ields 1 @ r . per ear.nd interest rate s"o. ¥206.1* .::.ed b /.ppose t"at on >an.mbers.!f t"e #?¥ spot rate is #1 .nds sterlin( and 7.1.al 218/1.ilibri.rn is *. ¥218 and interest rates in 3o2 o and Be) Cor2 are 6.ar 1 to FF 1 .rin( t"e ear.S. )"at is t"e e'pected spot rate in t)o ears- !NS&E"' <ased on 000.S.7+92.1* 9 .. 17. i. and t"e real re5.rin( t"e ear. and t"e e'pected inflation rate.m /disco.ar 1. )"at is t"e best estimate of t"e one9 ear for)ard e'c"an(e premi. From t"at.m relative to t"e Frenc" franc. 3"e inflation rate in Great <ritain is e'pected to be +.ro. d. #0. %. W"at )as t"e real U. t"e real interest rate a. in German and 9..t *. and inflation is e'pected to be :. for)ard premi. and t"e inflation rate in S)itAerland is e'pected to be 6..nd. on po. 1. 3o t"e nearest )"ole n.nd..0* .*.10 9 1 . /see D"apter 121. ::. inflation is *. t"erefore. inflation is r.0+12 . t"e cost of borro)in( Frenc" francs for t"e ear is 18.ld be 1. t"e franc deval.ate real interest rates across co.al rate of :.ntries and c.t 17. per ear..ld sell at aro. for interest rate parit to "old.nd in t)o ears is 12.::.18/1 9 .ar 1. )it" a 6.e of t"e po. 2. Since 6n(land8s nominal interest rate is 1+. 7t t"e same time. #0.*0..ro rate of 7. )e see t"at t"e real dollar cost of repa in( t"e franc loan is 9#0.m on t"e 6. >apan8s real interest rate is abo. 3"e nominal dollar cost of borro)in( Frenc" francs.late France8s nominal interest rate as abo.10 on %ecember :1.mber.rin( t"e ear. 1+. )"at is t"e e'pected #?¥ e'c"an(e rate one ear "ence- !NS&E"' 7ccordin( to t"e international Fis"er effect. respectivel .. S.rrencies.1. 9.bstit. for)ard premi. For eac" dollar8s )ort" of francs borro)ed on >an.ppose t"at in >apan t"e interest rate is 8. a(ainst t"e po.. inflation of *.nd a :. !f t"e 6. /8.. .S.7867$1.nd s"o. !NS&E"' 7ccordin( to interest rate parit .nnin( at an ann.7ss. and Frenc" inflation is 9. is 1 @ r .08. )as . r.. t"e e'pected val.ro is sellin( at a one9 ear for)ard premi. 6. and t"e 6n(lis" interest rate is 1+.

6*$£1.*+. a 6.09 9 11 or essentiall Aero. !n real po.rn of 1. !t involves borro)in( po...1:8*$1.nd deval. 3"e real interest rate in 6n(land is 1.01* ' 0. 9 7.ro e5.ld o. t"e German compan m. t"e real cost of borro)in( 6. /1$0. t"e cost of t"e po.nds.al po.W" - . /16.rin( t"e ear.1.ro appreciated b 1.02. o. respectivel . b. 4o)ever.se mone mar2et instr. t"e effective cost in 6.618*.ro is 1.nds. 3"e 69mont" interest rates on dollars and 6.nd loan factored in an e'pected deval.0189 9 11. !NS&E"' 7t t"e end of one ear.1. !NS&E"' %.nd "as deval.ro. W"at are t"e real costs to a <ritis" firm of borro)in( 6. t"is loan )ill cost t"e <ritis" firm 0. 4o) )o.6*$2.ments1 )o..rin( t"e ear t"e e'c"an(e rate c"an(es from 6.8*.8*. /2.ppose toda 8s e'c"an(e rate is #0.nds. 10.Dontrast t"is cost to its real cost of borro)in( po.rac of t"e advisor service8s forecast.ro bo.ro at :.ed b abo. .rn of 17. b.618*1 per 6. /2. t"ere is an arbitra(e opport. 3"e difference bet)een t"e e'pected and act.+8. d. in( 6.6+ 9 1.. loc2in( in a po.16$1.07 ' 1.*.ro..ments /borro)in( and lendin(1 to profit- !NS&E"' < borro)in( dollars at 6. and repa in( t"e dollar loan.ro )ill appreciate to #0. "i("er real cost of borro)in( po. W"at "appened is t"at t"e po.88.ro loan at 7. and t"en sellin( t"e proceeds for)ard.77..77. (iven t"e :. convertin( t"em to 6..S. a. W"at is t"e real interest rate in German .nd terms.16 ' /1 9 0.621 ' 1.021* /0. 6.618*1.0902$1.nd ret..ed a(ainst t"e 6.rn per dollar borro)ed . 3"e 69mont" for)ard rate is #0.88. semiann.nit .ro b 1. prefer.rn of :. /1. /:.1.7. t"e 6. W"ic" alternatives /for)ard contracts or mone mar2et instr.ld o.0: 91 .8*.nds is 6.ation of abo.ld o.Since t"e po. convertin( t"em into 6. t"e real interest on borro)in( po.62$6. :.ation- !NS&E"' < b.st repa . (iven a 9.nds.0: 91 .6* 9 11 a(ainst t"e po. o. 4ence.nts for t"e appro'imatel 7.6+ 9 0.Dontrast t"is cost to its real cost of borro)in( 6.se for)ard contracts to profit in t"e above sit.nd.ro for)ard for si' mont"s and sellin( it in t"e spot mar2et.09 91 .nds /1. semiann.ppose t"at d. 7s s"o)n above.ro are 6.ro.ro2.ation acco.ro. since t"e po.+2.? Eet.70 9 1 . )ill cost 9.nd interest rate is onl 16.018*1 9 1 .70$2. .nd onl deval.. can loc2 in an e'pected profit of #0. 1:. c.ro in t"e spot mar2et.nd loan is fo. 7 forei(n e'c"an(e advisor service "as predicted t"at t"e 6.ro2.nds at 16. in po. investin( t"e 6.nd as 1.ro.7$ £1 to 6. and :. )"ereas t"e po. 3"is is a semiann.021*$0. W"at are t"e real costs to a German compan of borro)in( po. )"ic" is si(nificantl lo)er t"an t"e real cost of borro)in( po. 4o) )o. 1.89.16 for ever po.all 1. /1. investin( t"em at 7. /0.nd borro)ed.all 1. rate of inflation in 6n(land.al ret. c.al percenta(e ret. W"et"er t"is profit materialiAes depends on t"e acc. S.6+ )it"in si' mont"s.("t for)ard..0: .als :.t 9.07$1.+2. 1*. 7s s"o)n above.in 6n(land- !NS&E"' 3"e real interest rate in German is 1.. )ill earn an e'pected semiann. sellin( t"e 6.02. 91.ro proceeds at an e'pected price of #0.6+$6..t 2. !n real terms. rate of German inflation.

se t"ese reso.rin( in >apan.blicl anno.n(ar 8s inflation rate )as 28.ld benefit from t"is increase in t"e real val.+7. )as 6. )"ile t"e forint /4.8*e0 ' /1. <ased on t"is e5.. and 1*. 7 f.281/1.rin( t"ose ears.ar 1. t"e 7merican eart"9movin( man. =t"er t"in(s bein( e5.rn .e of t"e en since Gomats. 4.rt"er t"e forint and t"ereb improve t"e cost competitiveness of its 3.:*1$J/1. deval. W"at mi("t "ave been t"e p.lb man. t"e e'c"an(e rate is #1 .ld not rise in dollar terms beca.nced c.n(arian (overnment t"at it )as in b.rin( 1991 )o. General 6lectric ac5. W"at "as "appened to t"e competitiveness of G68s 4. an increase of 8. a 4. inflation is +.rn per dollar in t"e for)ard mar2et is s.n(sram man. !n effect.S.ation d. Daterpillar 3ractor s"o.n(arian li("t b.sted dollar cost of >apanese9s. respectivel . deval. U.e of t"e en c"an(ed from #.pplied components and labor )ill rise in line )it" t"e increase in t"e real val.rin( t"e ear.. !n earl 1992. in 1991.fact. t"erefore. d.sin( t"e mone mar2et spec.n(sram Itd.e of t"e forint1 at t"e start of 1990 )as e0. t"e for)ard mar2et spec. d.00+000 /1$2*01 at t"e start of t"e ear to #.t press.0:11K .rces are imported. 7.!NS&E"' 3"e ret.t bac2 its capital investment in 3.rt"er 1*.ations "aven8t 2ept pace )it" 4.ld "ave left t"e nominal rate e5.n(sram. Dorrespondin( inflation for t"e U. dollar?>apanese en e'c"an(e rate is #1 .ation d.e of t"e forint red. 1.n(arian (overnment to deval. does most of its man.al to 0. !n 1990. =n %ecember :1.00+::9 /1$2:* ' 1. )e can see t"at t"e real e'c"an(e rate increased b 27. F2:*. Specificall .n(ar 8s c. %.9* ' 0.ation reflects t"e fact t"at if t"e nominal e'c"an(e rate /dollar val.tbac2- !NS&E"' G6 )as tr in( to p.fact.021 at t"e end of t"e ear. in 1990 and :.ldn8t ma2e a .lation )o.0+$1..siness to ma2e a profit and t"at if it co.re on t"e 4. F2*0.n(arian operations. 3"e s"arp appreciation in t"e real val.6.rer.8s ra) materials and ener( prices s"o.e of t"e en.ld c. t"en t"e *.ed *.e at t"e end of 1991 )as? 0.n(ar 8s roarin( inflation.9* ' 0. Cha(ter ))*a+ (roblem.e of t"e forint1 at t"e start of 1990 )as e0.rin( 1990 left it at 0.rpose of G68s p.9*e 0 b t"e end of 1990. )e 2no) t"at t"e forint8s real e'c"an(e rate "as risen. b.1. !NS&E"' Since forint deval.ired 3. W"at are t"e li2el competitive effects of t"is e'c"an(e rate c"an(e on Daterpillar 3ractor. Gomats.lation.rin( facilities.0611/1.fact. G6 anno.S.("est competitor is >apan8s Gomats.- !NS&E"' 3"e real val.S.bstantiall "i("er t"an t"e ret.rin( t"is t)o9 ear period. a. in 1991. =n >an.ced t"e cost competitiveness of G68s 4.rer.276e0 3"is e5.rrenc 1 )as deval.rin( 1990 and 19916'plain.1. and >apanese inflation is 2. if t"e nominal e'c"an(e rate /dollar val.n(arian operations d. t"e U. )"ose to.nced t"at it )o. in 1990 and :*. t"e forint8s real val. *.ld be preferred..ation. 3"e inflation9adH. G6 )as tellin( t"e 4.e f.8*e0 b t"e end of 1991.al.fact.

S. Sams.S.or )ill find t"at some of its costs are t"e same )"ile ot"er of its costs.rrenc of determination.S. 3".rin( Do.s.st pa t"e mar2et price. t"e face c. <lac2 O %ec2er &an. Donsider )"at )o.n(ar beca. dollar beca. 3"e are also becomin( more si(nificant e'porters of videocassette recorders and small micro)ave ovens. of 3o)son. rivals. 3"e 6dmonton =ilers /Danada1 of t"e Bational 4oc2e Iea(. for e'ample. 3"e bottom line is t"at <O%8s profits fall as t"e dollar rises and rise as t"e dollar falls.S. 7ssess t"e li2el conse5. 3". 1+. 0la er nationalit is irrelevant. t"e Danadian dollar salaries paid to t"e =ilers8 pla ers are H.ction mana(ement services. t"ese costs fall relative to t"ose of its forei(n competitors.. it )as not (oin( to invest t"ere in t"e f. 3"e =ilers )ill be forced to raise t"e Danadian dollar e5.ld be in U.rrenc .se t"e )on "as not risen b nearl t"e same e'tent a(ainst t"e dollar.e of all B4I teams.("l +*. color 3M mar2et )it" t"eir small.mp in its costs. Similarl .st e5. dollar e'c"an(e rate- !NS&E"' 3"e fact t"at t"e =ilers are paid in Danadian dollars does not affect t"e ans)er to t"is 5.ivalent of football8s S.st also fall b 10.(" man of t"e costs inc. 3"e "ave .s.or Dorporation.e t"eir c.per <o)l or baseball8s World Series. t"e 6dmonton =ilers )ill eit"er lose pla ers to U.# appreciates a(ainst t"e D#.ld "appen.c".or8s val.larl for t"e labor involved in desi(n.p pla off is "oc2e 8s e5. t"ese costs are t"e same for all potential competitors. "as ro. 11. &ar land. 7lt"o. labor in desi(n.rt b appreciation of t"e U. lo)9priced 3M sets.estion ver m.S. bot" its sales reven. "oc2e teams. Danadian teams compete in a )orld mar2et for talent and m.s. 18. /3"e Stanle D. partic.c" as 3ai)an or 3"ailand.ce t"eir cost advanta(e.al to )"at t"e pla ers8 salaries )o. !f t"e =ilers8 D# salaries are not raised. dollars converted into Danadian dollars. en(ineerin(. dollar depreciation.e are t)o9time defendin( Stanle D.ld ma2e mone .red more t"an 10.rrenc ris2 do t"ese firms face- !NS&E"' 3"ese firms "ave benefitted (reatl from t"e appreciation of t"e >apanese en a(ainst t"e U.("l in line )it" t"e rise of t"e dollar. as t"e dollar appreciates.ld red. Fl.p c"ampions. 3"is means t"at its profits )ill decline ro. .ttin( prices belo) t"e level at )"ic" t"e >apanese co. t"en profit m. mi("t deval. 3". t"e )ill find t"e are bein( paid less t"an pla ers on U.or )ill benefit from a fallin( dollar since it )ill be more cost competitive vis9a9vis forei(n contractors bot" at "ome and abroad.t. 1*. teams or "ave a "ostile team. !ts costs are primaril denominated and determined in dollars.S.. are no) lo)er.se of t"e "i(" forint and t"e res. &ost of Fl.S.t" Gorean companies s.profit in 4. 4ence.sed t"eir cost advanta(e vis9N9vis >apanese competitors to boost sales of lo)9end cons.ction9mana(ement services. 4o) are t"e =ilers affected b c"an(es in t"e Danadian dollar$U.1 7s is tr. sa .cts b c.re. =t"er)ise. t"e international constr.e and its costs decline appro'imatel in line )it" eac" ot"er. So.fact. and constr. 4o) does a soarin( dollar affect its profitabilit . t"e U. /!f bot" reven. s. of its sales overseas.# is t"e c.rred on forei(n proHects are set in t"e local c. most of t"e =ilers8 pla ers are Danadian.ivalent of its pla ers8 salaries to 2eep t"em on a par )it" t"eir U.ction9 en(ineerin( contractor based in !rvine.# vis9a9vis t"e D# and benefitted b U.S. and constr. Dalifornia. of its assets and +0.es and costs.rrencies a(ainst t"e )on.S.ltin( s"arp H. W"ile t"e D# is t"e c. !NS&E"' Fl.rrenc of denomination. in competin( a(ainst forei(n firms. en(ineerin(. bot" at "ome and abroad- !NS&E"' <lac2 O %ec2er "as a ro.(" balance bet)een forei(n sales and costs.es and costs fall.S.rrenc ris2 beca. t"e 6dmonton =ilers are ".ences of a declinin( dollar on Fl. W"at c.mer electronics prod.e9added involves proHect desi(n and mana(ementL most of its costs are for U. 10. Cen depreciation or )on appreciation )o.se competitors in ot"er nations.S. )"en t"e dollar declines. of t"e U. 3"at is. and %ae)oo "ave capt.c" as Goldstar.S.1 %ollar depreciation leads to correspondin( increases in dollar reven. if t"e U.n(.

ro and t"e S)iss franc )ill appreciate 6. GiAmo8s ban2 "as s.S. 7lt"o.ctive.rrentl controls abo.l to divide t"is problem into t)o iss.tomaticall .rin( "ard times.t )atc" competitors ta2e a)a orders.t" Goreans.rrent price levels )ere H.ctiveP tells o.mptions /11 and /21.t" Gorean )on "as maintained its dollar val.3"e So. >apanese s"ip ards are e'traordinaril prod.ilders.ce overseas. Bote t"at <O%8s domestic profitabilit is also affected b c.all .S. . !NS&E"' 3"e statement t"at P>apanese s"ip ards are e'traordinaril prod.late t"e loan )"ose expected U.t" Gorean s"ip ards (ained a s.bstantial fraction of )or2ers8 )a(es in t"e form of a semi9ann.ldn8t lo)er prices f. !f )e are . b.str is facin( a )orld)ide capacit s. from forei(n companies s. dollar loan :9 ear 6.S.str officials sa s"ip b.bstantial cost advanta(e vis9a9via t"e >apanese. P>apanese ind.sef. 3"e are no lon(er competitive in t"e commodit s"ip b. !f )e ass. #1. W"at are t"e li2el effects on >apanese s"ipb.S.rrenc front.S. :.t *0.t brea2in( even )it" an e'c"an(e rate of ¥2+0 . %efinin( t"e terms PcostP and Pris2P re5.ild an addition to its factor in 3oledo.t at c. We can do not"in( b. )"ic" enHo comparative reprieve on t"e c. t"en c. 4ence. ers no) a. 19. 7s t"e en appreciates a(ainst t"e )on. and ot"er So.t instead e'ported from its U.(" >apan c. So. dollar cost is t"e lo)est.s t"at is tied to corporate profits.("t.al bon.P 3"e onl de(ree of freedom to adH.siness. 3"e s"ipb.c" room for cost c.(" and man >apanese s"ip ards )ent ban2r. W"at information does GiAmo re5.s. U.rt"er.rpl.ilder costs too2 place on t"e )a(e side. !f t"e mar2et is anticipatin( t"at for t"e ne't t"ree ears t"e 6.e.c" as >apan8s &a2ita.n)illin( to ma2e ass. 7ccordin( to a stor in t"e Wall Street Journal.es1 t"en t"e e'pected cost of eac" loan is t"e same. t"en t"e e'pected U.ttin( b >apanese s"ip ards.pt.es? )"at is t"e e'pected cost and )"at is t"e ris2 of eac" alternative. dollar cost of eac" loan is t"e same. is investi(atin( medi. t"is decrease in labor costs )as not nearl eno. >apanese firms t picall pa a s.ire to decide amon( t"e t"ree alternatives- !NS&E"' !t is .ildin( ind. t"en )e need to .s. d. and 10.tomaticall b pass >apanese ma2ers. t.P >apanese s"ip ards "ave responded b desi(nin( innovative s"ips for )"ic" demand is price inelastic.ndai Dorp. >apanese s"ip ards )ill be devastated b a rise in t"e en.7. ="io.ilders of a en appreciation to ¥180 . Cha(ter ))*b+ (roblem.st abo. GiAmo.rrenc c"an(es since it faces competition in t"e U.m9term financin( of #10 million in order to b. #1. it is facin( severe competition from t"e So. t"at t"ere is not m. ann.ro loan :9 ear S)iss franc loan Eate 1+ 8 + a. labor costs fall a.rnin( instead to 4 .ires caref. b.ro and S)iss franc e'c"an(e rates to calc. plants. P3"e 8re alread at t"e bottom. as t"e )ere. of t"e )orld mar2et.l t"o.((ested t"e follo)in( alternatives? 3 pe of loan :9 ear U.!f <O% didn8t prod.rrenc c"an(es )o. 3". 7 spo2esman for t"e >apan S"ip 6'porters 7ssociation said t"at t"e co.st >apanese s"ipb.t" Gorean s"ipb.se independent forecasts of t"e 6.ld lead to m. 4o)ever.c" (reater s)in(s in its profits. respectivel .S.me t"at /11 t"e international mone mar2ets are efficient and /21 t"e international Fis"er effect "olds /t"ese are separate iss.

rrencies deval. !t can .rrenc ris2- !NS&E"' Bot ver li2el . said t"e %o) e'ec.ld contin.lar alternative.rpose. partic.e a(ainst t"e dollar . For e'ample.rope b s)itc"in( to 6.stomers li2el to respond to t"is ne) polic - !NS&E"' 3"e )ill simpl demand lo)er 6.. t"e polic )as fairer? < settin( t"e same %& price t"ro.ldn8t follo) %o) b. !t ma also be t"at for)ard mar2ets are more developed in one c. and forei(n competitors said t"at t"e )o. if GiAmo sells man prod. from t"ose of %o)8s competitors )"o are )illin( to c.rrenc . and if t"e firm see2s to red.ed so as to preserve its dollar mar(ins.tflo)s1. &oreover.rrencies1. 3"is ma establis" a nat. t"en t"is information )o.rrenc or t"at .e.rrenc ris2 from %o) to its 6.rrenc denomination of assets t"at GiAmo "olds as )ell as on t"e mar2ets in )"ic" GiAmo b.siness in local c.ts and sells it o.se t"ese receivables to pa off a %& loan and avoid t"e ris2s t"at are associated )it" an .ro appreciates or else lose mar2et s"are.rrenc )ill also depend on t"e so.ncertain #$6.se 6. W"at is t"e li2eli"ood t"at t"is ne) polic )ill red.ro prices. )as to s"ift c. a.rrenc of t"e co.t t"eir dollar or 6. )"ic" )ere erodin( from t"e deval. man of t"em )ill b. !n September 1992.ral "ed(e a(ainst a S)iss franc loan and red.cin( GiAmo8s e'pos.S.ntr based on c.ppose t"e factor )ill be b.rrenc are smaller even if t"e e'pected costs are t"e same.lar c.stomer in one compan mi("t "ave over competitors in anot"er co.ro prices if t"eir c. W"at is %o) reall tr in( to accomplis" )it" its ne) pricin( polic - !NS&E"' %o) )as reall tr in( to raise its prices in t"ose 6.sin( S)iss labor it alread "as S)iss franc o. t"en it probabl "as acco. t"e less .((est a S)iss franc loan.t if t"e S)iss factor is e'portin( to t"e U.ro pricin( to avoid mar(in erosion )"en 6. s its inp. b.rrenc ris2.e doin( b.lar ris2 level.r ans)er in part a- !NS&E"' !f t"e factor in Geneva sells in S)itAerland. %o) D"emical reacted to t"e c.ropean co. 4o) does t"is affect o. t"en some dollar financin( or financin( in t"e c. *. t"e ris2s associated )it" t"at c. %o)8s ne) polic )o. Unless all its leadin( competitors (o alon( )it" 6.ropean c.cts in 6. !n ot"er )ords. S)itAerland. rat"er t"an 3oledo.S.stomers.ilt in Geneva.ction process.rrencies deval.re /since b .tp.t 6.ro.ro price ever time t"e 6.t )o.ations. !f %o) doesn8t c. 3"is ris2 )ill depend on t"e c.nanticipated e'c"an(e rate c"an(es are smaller in one c.tive.cts in German . 3"e p.ld n.t its 6.rope.6ven if t"e e'pected cost of eac" loan is t"e same. t"e ris2 associated )it" eac" loan ma be different for GiAmo. %o) )ill "ave to c.nless it is )illin( to sacrifice mar2et s"are. b.rces of GiAmo8s inp. t"e relative amo. !f t"e e'pected cost of eac" loan alternative if t"e same.ld s.ro rate.rrenc c"aos in 6.ce %o)8s c.llif an advanta(e t"at a %o) c. and t"erefore.sef.nts receivable denominated in 6. !f t"e obHective is to minimiAe c.ts.rrencies deval. S.nt of financin( to do in eac" c. 3"e more labor9intensive t"e prod. said a %o) e'ec.ce t"e ris2 of t"is partic. <.("o.larl t"e e'tent to )"ic" it . %o) can8t . 4o) are %o)8s c. .rope. c.t its 6.ce total ris2. !f GiAmo desires a partic.ses S)iss labor.ro pricin( for all its prod. or is sellin( in t"e S)iss mar2et and facin( import competition.ro prices.ropean c.rrenc s)in(s. t"en GiAmo "as an asset )"ic" is essentiall denominated in S)iss francs.l S)iss franc financin( )ill be in red.tive.ro pricin( /its U.nties )"ose c.ntr in )"ic" its main competitors are located mi("t be appropriate. t"en it ma rationall prefer a partic.rrenc denomination for t"e loan.ts.

fficient to service bot" t"e interest and capital on t"e .es. a (ood part of >7I8s costs are for >apanese fli("t cre)s.cts for t"e items in t"e catalo(.rc"ase contracts )it" t"e s.(". b.sed to "ed(e p.t.al catalo(.st be borne in mind t"at t"ese are sec.S. principall from >apan. Dost 0l.e )ill li2el come do)n some)"at. 7lternativel . "as c"artered o. call options to cover its forei(n p.s )ill e'ercise t"em.rc"ases of U.t (ains or losses on t"e debts )ill be canceled o.ses t"e c.8.t t"at P7lt"o.rc"ases )it" dollars. in( t"e planes.ll on all loans and leases as if t"e "ad been repa able at :0 >. >7I "ad inc.re. t"e c"arters are off9balance9s"eet items. 4o) can I le . aircraft.re and )as .rrenc ris2. 3"is f.antit ris2 in addition to price ris2 s.lative forei(n e'c"an(e losses on t"at deal. 7 problem. some c. a <ritis" compan .t its semiann. 4o)ever. !NS&E"' Since I le "as c"artered o.rin( t"e life of t"e catalo(.al dollar o. 7cco. >7I "ad si(ned contracts to ta2e deliver of planes in t"e f. Dost 0l. 7s an alternative.("t #: billion of forei(n e'c"an(e contracts at ¥180$#1 over 11 ears to "ed(e its p. 7s t"e dollar rises a(ainst t"e po. !f a stron(er en means lo)er en operatin( profits.m.rred more t"an #1 billion in c. Dost 0l. %id >7I8s for)ard contracts constit. its c"airman pointed o.rc"ases. < 199+.mabl bo.cts? lo)9cost (oods pres.t o. I le S"ippin(.re income )ill offset t"e e'c"an(e losses no) provided for. t"en t"ese for)ard contracts )o.s !mports is a West Doast c"ain specialiAin( in lo)9cost imported (oods.P 1:. Some factors to consider in decidin( )"et"er t"is is li2el to be t"e case are as follo)s. prices of s. !n t"is case. planes financed b borro)in( dollars.ntants )ill note t"at I le bears si(nificant translation e'pos. !t "as to p.s s"o.e of t"e dollar t"at )o. is t"at if t"e forei(n c.s sales.rc"ases .bstit. I le can offset t"ese contract.nderl in( loans. t"o. t"e for)ard contracts co.t.rrent rate met"od to translate forei(n c.("t from Dost 0l.s co. it "as fi'ed dollar reven.s prod. )"en t"e dollar rose.re. < financin( its s"ip p.te prod.te an economic "ed(e.tflo)s.se financin( to "ed(e a(ainst its e'pos.3"at is. >apan 7irlines />7I1 bo.rrenc assets and liabilities.s co.r recommendation affect I le8s translation e'pos. 7dvise Dost 0l. <.I le .t at fi'ed frei("t rates. 11.re. it m.bstit. t"e firm )on8t e'ercise its optionsL if t"e rise above t"e call price.(" forei(n e'c"an(e losses "ave no) been provided for in f.nd. costin( Dost 0l. First.ld constit. 3"is is ver li2el "ere (iven t"e nat.e )it" prices t"at are (ood for si' mont"s.((ests t"at Dost 0l.ld "ed(e less t"an 100.s )ill decide to b.s )ill t picall ne(otiate p. W"at )as t"e economic rationale be"ind >7I8s "ed(es- !NS&E"' &ost li2el .9dollar frei("t rates.S.t s"ips at fi'ed9U.tes.e d.t ¥100$#1.re of Dost90l. Dost 0l.e. )it" t"e en at abo.e.ld "ed(e t"ese p.s !mports on "o) it can protect itself a(ainst c.te an economic "ed(e. I le )ill s"o) losses on its dollar debt and vice versa )"en t"e dollar falls.al dollar inflo)s )it" contract.S. )"ose pa is . 3"e e'istence of 5. !n 198*.S.c" as Dost 0l. !f t"e forei(n c.rrencies drop belo) t"e call option price. t"e c"eaper s.ld increase t"e en cost of b.sin( for)ard contracts. is it li2el t"at >7I8s losses on its for)ard contracts )ere offset b c. dollar income from )"ic" )ill be s.sin( for)ard contracts to protect itself a(ainst a rise in t"e val.ppliers of its catalo(.t over time b c"an(es in its operatin( cas" flo)s.ld b.e merc"andise in advance. of its proHected sales.("t b a price9sensitive clientele.red a(ainst s"ips c"artered o.estion depends on )"et"er >7I8s en operatin( profits are ne(ativel correlated )it" t"e en8s val. !NS&E"' 7 compan s. t"e U.rc"ases of U.rrenc (ains on its operations- !NS&E"' 3"e ans)er to t"is 5.ld "ave been .4o) )ill o. a. !n 198+.stomers )"o mi("t "ave bo.t its s"ips in dollars.rrencies deval.ne 198+.

re travelers since t"e en8s stren(t" "as led . so t"at t"e ver same event t"at led to a decline in t"e en val.e of t"e dollar.ld also "ave ta2en o.e of "is b.sl red. 7t t"e same time.ld fall a(ainst t"e en and t"at t"e dollar reven. 4e co.ildin( five ears later.ld not 2eep .ildin(. Bot"in( )o.ld "ave protected t"e investor from t"e decline in t"e b.me. W"ere t"e balance lies is an empirical 5. o. !n 1990.rc"ase- !NS&E"' 3"e ris2 is t"at t"e val.t costs. b.ildin( b borro)in( dollars.t a lon(9dated for)ard contract to "ed(e t"e en val. t"e e'c"an(e rate )as ¥1+*$#1.ts and "irin( forei(ners.e1. W"at e'c"an(e ris2 did t"e >apanese investor face at t"e time of "is p.me b. >7I8s en profits )ill var inversel )it" t"e en8s val.t fe)er 7mericans to visit >apan. !t t.ce more >apanese to travel to t"e U.e of "is asset99namel .ld t"e investor "ave "ed(ed "is ris2- !NS&E"' 3"e investor co. b.mbers of >apanese to.ildin(8s val.rc"ase of t"e b.estion. .ld "ave financed "is p. a stron(er en )ill ind. primaril b red.nprecedented n. in earl 199*.rt b en appreciation and is no) loo2in( to c.ildin( in do)nto)n Ios 7n(eles.rists to travel abroad.ildin(8s dollar price.rns o. t"e e'c"an(e rate )as ¥8*$#1 and t"e b. 16. 3o t"e e'tent t"at fares are determined in dollars /in part beca. 4o) co.denominated and determined in en. a dollar decline99 )o. airlines.ld sim.cin( its >apanese )or2 force t"ro.e "ad collapsed to #*0 million.e of t"e dollar )o.ce t"e en cost of t"e liabilit .S. a. a >apanese investor paid #100 million for an office b.sed more on servin( leis. W"en t"e investor )ent to sell t"e b. increasin( o.cin( inbo.S.se >7I is competin( )it" U.sed to finance t"at asset.tbo.ltaneo.es )o. !t "as also foc.t red.p )it" t"e decline in t"e val.(" Hob b. 7t t"e time.nd vol.t t"at >7I "as been ".nd vol.