a) A U.S. firm that exports most of its products to Canada. Initially its products were invoiced in Canadian dollars to accommodate the importers. After a few more years of continual concern about possible exchange rate movements, it requested its Canadian customers to pay for future orders with U.S. dollars instead of Canadian dollars. The customers decided to oblige, since the number of Canadian dollars to be converted into U.S. dollars when importing the goods from the U.S. firm was still slightly smaller than the number of Canadian dollars that would be needed to buy the product from a Canadian manufacturer. Based on this situation, has transaction exposure changed for the U.S. firm? Has its economic exposure changed? Explain.
IS-LM-PC Analysis
The IS (Investment Saving), LM (Liquidity Preference- Money Supply), and PC (Philips Curve) is the model that looks at the dynamics of output and inflation. It takes into account the central bank policy decision to adjust the inflation and real interest rate in the economy. It enables the economist to weather to priorities between employment and inflation rate analyzing the model. It is a practice-driven approach adopted by economists worldwide.
IS-LM Analysis
The term IS stands for Investment, Savings, and LM stands for Liquidity Preference, Money Supply. Therefore, the term IS-LM model is known as Investment Savings – Liquidity preference money Supply. This model was introduced by a Keynesian macroeconomic theory which shows the relationship between the economic goods market and loanable funds market or money market. In other words, it shows how the market for real goods interacts with the financial markets to strike a balance between the interest rate and total output in the macroeconomy. This particular model is designed in the form of a graphical representation of the Keynesian economic theory principle. The output and money are the two important factors in an economy.
- a) A U.S. firm that exports most of its products to Canada. Initially its products were invoiced in Canadian dollars to accommodate the importers. After a few more years of continual concern about possible exchange rate movements, it requested its Canadian customers to pay for future orders with U.S. dollars instead of Canadian dollars. The customers decided to oblige, since the number of Canadian dollars to be converted into U.S. dollars when importing the goods from the U.S. firm was still slightly smaller than the number of Canadian dollars that would be needed to buy the product from a Canadian manufacturer.
Based on this situation, has transaction exposure changed for the U.S. firm?
Has its economic exposure changed? Explain.
- b) A U.S. firm which has no other international business, plans to create and finance a subsidiary in Mexico to produce computer components at a low cost and export them to Caribbean islands and will invoice the products in U.S. dollars. The values of the currencies in the islands are expected to remain very stable against the dollar. The subsidiary will pay wages, rent, and other operating costs in Mexican pesos. The subsidiary will remit earnings monthly to the parent
- i) How would the U.S. firm’s cash flows be affected if the Mexican peso
depreciates over time? - ii) The U.S. firm now considers partial financing of this proposed subsidiary with peso loans from Mexican banks instead of providing all the financing with its own funds.
Would this alternative form of financing increase, decrease, or have no effect on the degree to which the U.S. firm is exposed to exchange rate movements of the peso?
- c) An Indian MNC that has a large government contract with South Africa. The contract will continue for several years and generate more than half of this MNC’s total sales volume. The South African government pays the Indian MNC in South African currency. About 10% of this MNC’s operating expenses are in South African currency; all other expenses are in INR. Explain how this Indian MNC can reduce its economic exposure.
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