GEE Group 7 (Question 3 (a. 3 important types of exposure to currency…
GEE Group 7
b.ii. Expected effect on the exchange rate between and ¥ and $
PPP theory: ¥ depreciates by 4%
b.ii. What would the Fisher effect imply about the
expected difference in inflation rates ?
b.i. What will be the adjusted exchange rate between currencies?
40/Pusd = 8 --> Pusd = 40/8 = 5 Yen --> exchange rate will be 5 Yen for 1 USD
b.i. how the current exchange rate between ¥ and $ will get adjusted according to Law of One Price?
People will do this: In NP convert ¥32 : to $8; Buy in SP stick for $8 --> arbitrage $2 or ¥8
Result: D$ increases --> $ appreciates; S¥ increases --> ¥ depreciates --> exchange rate adjusted
a. 3 important types of exposure to currency exchange rate fluctuations:
Stanley Black & Decker
In 2015 Apple reported a record revenues of $15.4 billion, however in absence of foreign exchange volatility it would be 4% higher according to Apple's CFO
Embraer Case (Question 1)
c. Who suffers from devaluation of the yen?
Common citizens of Japan because they suffer from the higher price level
Long-term thinkers, who afraid from reaction of other countries
c. Who benefits for devaluation of the yen?
Exporters in Japan (like Toyota)
Abe's government - promised to depreciate and did it
a. What drove an increase of yen value?
Financial crisis in the US --> Lower interest rates in the US --> Carry trade is profitable no more --> Less Supply of Yen --> Appreciation of Yen
Financial institutions sold dollar-denominated assets and bought yen-->Demand in yen increased-->yen value increased
b. Why Abe's policy helped drive down the yen value and what was the mechanism?
Central Bank of Japan purchases government securities --> More liquidity in the market (more Yens) --> Supply of Yen increases faster than increase in output --> inflation (money supply and price inflation)--> Yen depreciation (according to PPP Theory)
b. Agree with decision to stop using forwards?
Unless a firm has valid reason to believe that their currency will greatly appreciate between the contract period, a forward may not work in their favor, as with Embraer's case
Agree, forwards provide insurance against appreciation, however limit firm's profits potential from depreciation. when a market is so volatile as Brazilian it might not be worthy
Don't agree, it's not forward's fault, they are just a tool, that should be used properly
a. Alternative options rather than forward contracts
Disperse production to different location
Deposit revenue in US bank in US dollor
Use lead and lag strategies
Collect payments from customer earlier (receive $ later and convert to real)
Pay suppliers later (if real appreciates, you'll pay less)
Price its aircraft in real(assume transaction between US and Brazil; feasible? )
b. Could losses be prevented?
Backwards thinking, of course, how ever it was their business decision that failed because of unpredictable circumstances
Agreement On Exchange Guarantees(both sides agree to adjust sum of money in proportion in the process )
Factoring(transfer the risks to factor)
b. Takeaways about forward market
It not only provide insurance, but also imposes new risks
Fluctuations in the foreign exchange market greatly impacts profitability of issurances.
Currency hedging is beneficial if a firm's currency appreciates in value. In Embraer's case, the real depreciates however the contract locked the firm into a much high real to usd exchange rate.