Determine the effects of Real Exchange Rates upon

MBA 6651, International Finance 1Course Learning Outcomes for Unit IVUpon completion of this unit, students should be able to:
1. Determine the effects of Real Exchange Rates upon transactions, including the associated risk.
2. Surmise the appropriate steps to managing real exchange risk.
3. Examine how exchange rates are determined and their impact upon forecasting for future
transactions.Reading AssignmentChapter 9:Measuring and Managing Real Exchange RiskChapter 10:Exchange Rate Determination and ForecastingUnit LessonWe begin the lecture with how firms respond to real exchange risk with their pricing, marketing, and
production policies. Pricing is a major factor when dealing with real exchange risk. For example, when BMW
started producing automobiles in the United States, it started in South Carolina. Why would a German
company like BMW build a plant in South Carolina? A few factors are involved. When BMW made the
decision to have a plant in the United States, they looked at the labor, tax breaks, and the exchange rate
converting dollars to euro. Pricing was the reason for the move. Labor was also a key issue, as making the
automobile in Germany would have cost the firm 30 euro per hour, compared to paying an American worker
24.50 euro per hour. The next key was the tax breaks which the company received; they received enormous
tax breaks to induce them to locate there. The exchange rate was another factor.
When a vehicle is built in Germany and is shipped to the United States, the firm must convert the value of the
automobile from euro to dollars and therefore may cause less of a profit for the firm, depending on the value
of the dollar converted to the euro. This risk caused the firm to decide to establish a plant in the United States;
for this case one would make the decision on the value of the automobile and what it cost to build on the
worth of the dollar. When the automobile is made in Germany a depreciation of the dollar can create a loss of
value when the profits are converted into euro, and there is pressure to increase the dollar price of the car to
offset dollar depreciation. During the 1980s, the value of the dollar was high and therefore military personnel
that were stationed overseas in Europe would bring back European vehicles. Some could purchase a
190e Mercedes for as little as $15,000 or less. The exchange rate for the DM to the dollar was 3 DM to 1
dollar. (Crum, 2005)
Another factor to consider is the marketing strategies and managing real exchange risk in the pricing-tomarket, which refers to how producers charge different prices for the same good in different countries. For
example, Apple iPads and iPhones cost less in the United States than in other countries. When Apple sells
their iPhones to a telecommunications service provider in the United States, such as T-Mobile or Sprint, the
telecom provider gets the phones at a discounted rate. The telecom provider makes their money by signing
the consumer into a two-year service contract. However, when selling phones to other countries, they are
required to unlock the phone so the consumer can use it with any telecom service provider. (Bekaert, 2012)
A firm’s profitability can change due to the fluctuations in the real exchange rate, such as the production
policy. Depreciation in a domestic currency hurts importing firms and helps exporting firms exposed to real
exchange rates without having direct exposure to foreign currency cash flow. For example, Greece produces
80% more extra virgin olive oil than any other country. However, as of recently the Greek economy has facedUNIT IV STUDY GUIDEExchange Rates: Managing
and Forecasting RiskMBA 6651, International Finance 2UNIT x STUDY GUIDETitlehardship, and while exports of Olive Oil are high they cannot account for the bulk of the country’s GDP. In a
country of 11 million, only 3.7 million people have jobs, down from 4.6 million four years ago. Economic
activity has shrunk by over 20% in that time. With the fluctuations of the exchange rate of the Euro, the other
countries were willing to assist Greece since the Euro is attached to the same currency. (Shea, 2009)
Financial institutions devote substantial res…

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