International Business Assignment Number 2

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BUS 350
International Business
Assignment #2

Answer1:Drawing on what we know about the Fisher effect, the real interest rate in both the US and South Korea is 2%. The international Fisher effect suggests that the exchange rate will change in an equal amount but in an opposite direction to the difference in nominal interest rates. Hence since the nominal interest rate is 3% higher in the US than in South Korea, the dollar should depreciate by 3% relative to the South Korean Won. Using the formula from the book: (S1 - S2)/S2 x 100 = i$ - iWon and substituting 7 for i$, 4 for iWon, and 1200 for S1, yields a value for S2 of $1=W1165.

Answer2: (a) According to PPP, the $/£ rate should be 2.80/3.70, or .76$/£. (b) According to PPP, the $/£ one year forward exchange rate should be 3.10/4.65, or .67$/£. (c) Since the dollar is appreciating relative to the pound, and given the relationship of the international Fisher effect, the British must have higher interest rates than the US. Using the formula (S1 - S2)/S2 x 100 = i£ - i$ we can solve the equation for i£, with S1=.76, S2=.67, I$ = 10, yielding a value of 23.4% for the British interest rates.

Answer3: (a) When Volkswagen decided to hedge just 30 percent of its foreign exchange exposure in 2003, the company essentially gambled that the euro would decline in value relative to the dollar. The company hoped that by saving the cost of the commission involved in selling a currency forward, it would increase its profit margin. This strategy of course, backfired. b) The appreciation of the euro relative to the U.S. dollar took many people by surprise. Its rise has been attributed to record U.S. foreign trade deficits and pessimism about the future value of the dollar. c) In addition to using forward contracts, Volkswagen could use currency swaps, and lead and lag payables and receivables.

Answer4: The simplest solution would be to just wait until December, take the ¥400,000 and...
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