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10 Feb 2018

Assume that you are the international cash manager of XYZ Inc. Because your firm exports goods to Mexico, your job as international cash manager requires you to forecast the value of Mexico’s with respect to the dollar. Explain how each of the following conditions will affect the value of the peso, holding other things equal. Then, aggregate all of these impacts to develop an overall forecast of the peso’s movement against the dollar.

a. U.S. inflation has suddenly decreased substantially, while Mexico’ inflation remains low.

b. U.S. interest rates have decreased substantially, while Mexico’s interest rates remain low. Investors of both countries are attracted to high interest rates.

c. The U.S. income level decreased substantially, while Mexico’s income level has remained unchanged.

d. The U.S. is expected to impose a small tariff on goods imported from Mexico.

e. Combine all expected impacts to develop an overall forecast.

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Tod Thiel
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12 Feb 2018

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Mexico tends to have much higher inflation than the United States, as well as much higher interest rates. Inflation and interest rates are much more volatile in Mexico than in industrialized countries. The value of the Mexican peso is typically more volatile than the currencies of industrialized countries from a U.S. perspective; it has typically depreciated from one year to the next, but the degree of depreciation has varied substantially. The bid/ask spread tends to be wider for the peso than for currencies of industrialized countries.

a. Identify the most obvious economic reason for the persistent depreciation of the peso.

b. High interest rates are commonly expected to strengthen a country’s currency because they can encourage foreign investment in securities in that country, which results in the exchange of other currencies for that currency. Yet the peso’s value has declined against the dollar over most years, even though Mexican interest rates are typically much higher than U.S. interest rates. Thus it appears that the high Mexican interest rates do not attract substantial U.S. investment in Mexico’s securities. Why do you think U.S. investors do not try to capitalize on the high interest rates in Mexico? c. Why do you think the bid/ask spread is higher for pesos than it is for currencies of industrialized countries? How does this affect a U.S. firm that does substantial business in Mexico?

Assume that you are the international trade manager of XYZ Inc. Because your firm exports goods to Mexico, your job as international trade manager requires you to forecast the value of Mexico’s peso with respect to the dollar and its effects on your firm’s exports to Mexico. Last year, your firm exported one billion peso worth of products to Mexico. The exchange rate between US dollar and Mexican peso was $0.20/peso. Now, you are expecting that the following changes will take place in the markets. Assume that everything else remains same.

1. Last year, the inflation rate in the US was 3% and 8% in Mexico. Now, you are expecting that the following change will take place in the markets. Next year, the inflation in the US is expected to be 2% while it will increase to 9% in Mexico. With each percentage change in the differential inflation, there will be a 5% change in the demand for exports by the Mexican customers. In addition, for each percentage change in the differential inflation, there will be a 1.5% change in the value of the Mexican peso. Explain how the above changes will affect the value of exports of your company to Mexico.

2. Last year, GDP growth rate in the US was 2.5% while it was 3% in Mexico. Next year, you expect that the national income of US will increase by 3% while Mexican national income will increase by 4.5%. For each percentage change in the differential national income, there will be a 3% change in the demand for the exports of your company’s products. In addition, for each percentage change in the differential national income, there will be a 2% change in the value of the peso. Explain how the above changes will affect the value of exports of your company to Mexico.

Compute the expected return of a portfolio given these three economic states, their likelihoods, and the potential returns:

Economic State Probability Return

Fast Growth 20.00% 30.00%

Slow Growth 50.00% 6.00%

Recession 30.00% -2.00%

Answer


8.40%



11.33%



12.65%



15.47%

Compute the standard deviation of a portfolio given these three economic states, their likelihoods, and the potential returns:

Economic State Probability Return

Fast Growth 20.00% 30.00%

Slow Growth 50.00% 6.00%

Recession 30.00% -2.00%

Answer


1.28%



4.36%



7.82%



11.34%


Year-to-date, Company O had earned -2.10% return. During the same time period Company V earned 8.00% and Company M earned 6.25%. If you have a portfolio made up of 40.00% Company O, 30.00% Company V, and 30.00% Company M, what is the overall portfolio return?

Answer


5.778%



4.270%



6.871%



3.435%


Risk that CAN BE eliminated through proper diversification is called _____.

Answer


market risk



firm-specific risk



systematic risk



non-diversifiable risk


GIVEN: Spot Rate: 1 X = 1.02 Y
30 Day Forward Rate: 1 X = 1.15 Y
Your currency is "X" and you will be paying 345Y. You would ____ because _____.

Answer


pay now; of the irrelevance of payment time



pay now; it will take less "X"



pay in 30 days; it will take less "X"


The amount of one currency needed to purchase one unit of another currency is the _____.

Answer


derivative rate



exchange rate



backwardation rate



over-the-counter rate


The price of an option is called a(n) _____.

Answer


expiration cost



holding cost



premium



proceeds


When a futures contract expires, the parties usually _____.

Answer


have a party when losses are low



take delivery of the contract asset



do a cash settlement



swap off liabilities.


When a forward contract expires, the parties will _____.

Answer


have a party when losses are low



deliver the contract asset



do a cash settlement



swap off liabilities.


Any asset whose value is derived from the value of some underlying asset is a(n) ____.

Answer


derivative



primary capital



spot asset



intermediary asset


Which of the following is not traded on an exchange?

Answer


options



futures



forwards



they are all exchange-traded


A system under which a country's exchange rates are tied to another currency by government policy is _____.

Answer


floating exchange rates



pegged exchange rates



convertible exchange rates



forward rates


One of the _______ for business with a floating exchange rate system is the _______ planning business activities in an international market.

Answer


disadvantages; difficulty of



advantages; easiness of



irrelevant situations; normal



none of the above


U.S. dollars deposited in foreign banks are called _____ and interest paid on these deposits is normally tied to _____.

Answer


non-foreign deposits; FED funds rate



indirect dollars; Discount Funds Rate



Eurodollars; LIBOR



none of the above


____ is a disadvantage of the gold standard.

Answer


Excess currency slowing economic growth



Excess inflation



A non-variable beta



Lack of currency to promote continued economic expansion


A monetary system in which paper money can be converted directly to gold is a(n) ___.

Answer


dollar backed float



gold standard



currency float



Americanized gold standard



none of the above


Reason(s) for the Great Depression following the Great War include:

Answer


trade protectionism



isolationism



nationalism



all of the above



none of the above


An agreement between the WW II allies in 1944 designed to prevent the problems leading to the Great Depression and WW II and to rebuild Asia and Europe was the _____.

Answer


Armistice of 1945



Bretton Woods Agreement



Lend Lease Act for Asia and Europe



none of the above


A derivative is used to ____ thereby _____.

Answer


float; gaining excess currency for expansion



peg currency; improving trade with a primary partner



hedge; reducing/eliminating risk



none of the above


Easier business planning is an advantage of the ______ system.

Answer


mixed exchange rate



floating exchange rate



derivative exchange rate



gold standard



none of the above


____ is the chance that some unfavorable event will occur.

Answer


Expected return



Risk



Coefficient of variation



Correlation



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