fm12 ch 26 p15 build a model

1/12/2008

Chapter 26. Ch 26-15 Build a Model

TABLE 26-1 (abridged)Exchange rates of select major currencies, relative to the U.S. dollar

Direct IndirectQuotations Quotations

British pound 1.9069 0.5244Mexican peso 0.0919 10.8778Euro 1.2841 0.7788Japanese yen 0.0087 115.1145

TABLE 26-2 (abridged)

Dollar Euro Pound Peso YenJapan 115.11450 147.8185 219.5118 10.5825 ....Mexico 10.87780 13.9682 20.7429 .... 0.0945United Kingdom 0.52440 0.6734 .... 0.0482 0.0046Euro 0.77880 .... 1.4850 0.0716 0.0068United States .... 1.2841 1.9069 0.0919 0.0087

a. How much, in dollars, does it cost for Yohe to produce the SY-20? What is the dollar sale price of the SY-20?

Input DataCost of component X (in euros € 84Cost of component Y (in pesos) 650Cost of component Z (in pounds) £105Sale price of the SY-20 (in yen) 38,000

We will convert the cost of each component to dollars, and find the total cost of the SY-20. We will do the same to find the dollar sale price.

Yohe Telecommunications is a multinational corporation that produces and distributes telecommunications technology. Although its corporate headquarters are located in Maitland, Florida, Yohe usually must buy its raw materials in several different foreign countries, and several different foreign currencies. The matter is complicated even further by the fact that Yohe usually sells its products in other different foreign countries. One product in particular, the SY-20 radio transmitter draws its principal components Component X, Component Y, and Component Z from Germany, Mexico, and England, respectively. Specifically, Component X costs 84 euros, Component Y costs 650 Mexican pesos, and Component Z costs 105 British pounds. The largest market for the SY-20 is in Japan, where it sells for 38,000 Japanese yen. Naturally, Yohe is intimately concerned with economic conditions that could adversely affect dollar exchange rates. You will find Tables 26-1, 26-2, and 26-3 useful for this problem.

Note: The pound and euro are quoted as direct quotations. Other currencies are quoted as indirect quotations.

Key Currency Cross-Exchange Rates b

A B C D E F G H I12

3

4

5678910111213141516171819202122232425

26

272829303132333435363738394041424344454647484950

Component XCost of X in $ = Cost in euro x Direct spot exchange rate ($/euro)Cost of X in $ = xCost of X in $ =

Component YCost of Y in $ = Cost in pesos x Direct spot exchange rate ($/peso)Cost of Y in $ = xCost of Y in $ =

Component ZCost of Z in $ = Cost in pounds x Direct spot exchange rate ($/pound)Cost of Z in $ = xCost of Z in $ =

TOTAL COST OF THE SY-20 (in dollars) =

Revenue from sale of the SY-20Sale price (in $) = Price in yen x Direct spot exchange rate ($/yen)Sale price (in $) = xSale price (in $) =

SY-20 SALES PRICE (in dollars) =

b. What is the dollar profit that Yohe makes on the sale of the SY-20? What is the percentage profit?

The dollar profit from the sale of the SY-20 is simply the sales revenue minus the total cost.

Dollar profit = Sales price - Total costDollar profit = -Dollar profit =

The percentage profit is determined as the dollar profit divided by the total cost.

% profit = $ profit / Total cost% profit = /% profit =

c. If the U.S. dollar were to weaken by 10% against all foreign currencies, what would the dollar and percentage profits be for the SY-20?

Change in dollar strength against all currencies

We will reproduce the table from the top of the spreadsheet, but we will add a column for the new exchange rates.

Direct Indirect New DirectQuotations Quotations Quotations


Since there is a weakening of the dollar, a dollar buys fewer units of foreign currency and a unit of foreign currency buys more dollars. Therefore, if the dollar were to weaken by 10% against all currencies, that could be expressed by multiplying the direct quotations of foreign exchange rates by (1 + % change).

A B C D E F G H I51525354555657585960616263646566676869707172737475767778798081828384858687888990919293949596979899100101102103104105106107

Now, we will recompute the component costs and sales price of the SY-20.

Component XCost of X in $ = Cost in euros x Direct spot exchange rate $/euro)Cost of X in $ = x

New cost of X in $ =

Component YCost of Y in $ = Cost in pesos x Direct spot exchange rate ($/peso)Cost of Y in $ = x

New cost of Y in $ =

Component ZCost of Z in $ = Cost in pounds x Direct spot exchange rate ($/pound)Cost of Z in $ = x

New cost of Z in $ =




A B C D E F G H I108109110111112113114115116117118119120121122123124125126127128129130131132133





Change in dollar strength against Japanese yen

Direct Indirect New DirectQuotations Quotations Quotations


Now, we will recompute the component costs and sales price of the SY-20.

Component XCost of X in $ = Cost in euros x Direct spot exchange rate ($/euro)Cost of X in $ = x

New cost of X in $ =

Component YCost of Y in $ = Cost in pesos x Direct spot exchange rate ($/peso)Cost of Y in $ = x

New cost of Y in $ =

Component ZCost of Z in $ = Cost in pounds x Direct spot exchange rate ($/pound)Cost of Z in $ = x

New cost of Z in $ =



From this exercise, we see that since all costs and revenues are generated overseas, an across the board weakening of the dollar does not result in any changed profitability for Yohe's SY-20. The lack of changed profitability may seem surprising because of the significant increase in the dollar sales price, but remember that same increase was observed in the dollar cost of the SY-20.

d. If the U.S. dollar were to weaken by 10% only against the Japanese yen and remained constant relative to all other foreign currencies, what would the dollar and percentage profits be for the SY-20?

Once again, we must reconstruct the currency table from the top of the worksheet. This time, however, we will only be changing the exchange rate for the yen. Again, we will be multiplying the old rate by (1 + % change). Since there is a weakening of the dollar, that is an increase in the direct quote.

A B C D E F G H I134135136137138139140141142143144145146147148149150151152153154155156157158159160161162163164165166167168169170171172173174175176177178179180181182183184185186187188189190191






In this instance, we observe that a weakening of the dollar against the yen (all else equal) will result in higher profitabilityfor Yohe.

Applying interest rate parity, we can determine the return on 1-year securities in England.

TABLE 26-3 (abridged)Forward exchange rates for the British pound

Forward RatesSpot Rate 30 days 90 days 180 days

British Pound 0.52440 0.5242 0.5237 0.5231

Using our knowledge of interest rate parity, the following problem is set up.

spot exchange rate (direct quotation) =forward exchange rate (direct quotation) =home nominal interest rate = 4.9%time to maturity on securities (in years) = 0.25home periodic interest rate =

= /

= /

=

= periodic

= annual

f. Assuming that purchasing power parity holds, what would the sale price of the SY-20 be if it were sold in England, rather than Japan?

Purchasing power parity allows us to establish the following problem.

Price in yen =Exchange rate (yen/pound)=

= x

= x

(in pounds) =

e. Using the forward exchange information from Table 26-3, calculate the return on 90-day securities in England, if the rate of return on 90-day securities in the U.S. is 4.9%?

f t / (spot exchange rate) (1+r h) 1+rf

1+rf

1+rf

rf

rf

P h ( P f ) ( e0 )

( P f )

( P f )

A B C D E F G H I192193194195196197198199200201202203204205206207208209210211212213214215216217218219220221222223224225226227228229

230

231

232

233234235236237238239240241242243244

245

246247248

B218

This is the indirect spot rate.

fm12 ch 26 p15 build a model

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