Question

Mercedes rises its C300 price in the U.S from $40,000 to $41,500 in response to a movement of the exchange rate from $1.1000/EUR to $1.1600/EUR.

A. What is Mercedes's percentage exchange rate pass-through in this case?

B. Please provide four reasons (Key words) to explain why multinational corporations can survive without a complete exchange rate pass-through.

Answer 1

A.) % Change of Exchange Rate = (New Rate - Old Rate)/ Old Rate = (1.16 - 1.1 )/ 1.1 = 5.4545%

% Change in Mercedes Price = (New Rate - Old Rate)/ Old Rate = (41500 - 40000 )/ 40000 = 3.75%

Hence Mercede's percentage exchange rate pass through = 3.75 / 5.4545 = 68.75%

B)

• Already high margins are incorporated in the original cost of Mercedes. Although for a premium product demand is inelastic to price, a very high change in price wight result in consumers going to the competitor to buy the product. Hence in order to retain the consumer, companies dont mind to take a small hit to the margins
• Natural Hedge: Company might be having some dollar expenses which can be fulfilled by dollar revenues. Hence these expenses act as a natural hedge to some extent
• Forward Contracts: Companies might have entered into a forward contract if the delivery takes some 1-2 months. Hence company can estimate the dollar inflows for which necessary hedging instruments might have been entered by the company.
• Company might expect the dollar fluctuation not in favour of the company might come back the the median levels. Hence company might have a policy that to a certain extent if the exchange rate moves, whether in favour or not in favour, no action on the prices will be taken, post which action might be taken on the price of the product.