1. Suppose that one euro costs 80¢ on January 1. Suppose that on March 1, one...

1. Suppose that one euro costs 80¢ on January 1. Suppose that on March 1, one euro costs 75¢. What has happened to the value of the dollar (in terms of euros) over this period? 2. Using the information in Exercise 1, imagine that you are a purchasing agent for a domestic firm and you are thinking about buying goods from a European firm. Suppose the total value of those goods is €500,000. How much would you have spent if you’d purchased the goods in January? How much if you’d waited until March? Suppose you knew in January that you wanted to buy the goods, but that you wouldn’t actually make the expenditure until March. What action(s) could you take in January?

Expert Solution

Exercise 01.

Appreciation and depreciation of currency is calculated with the help of forward and spot rate of currency. Formula for change in exchange rate is as follow:

(Forward rate - Spot rate ) / Spot rate

In respect of direct quote If it is positive then foreign currency is appreciated and if negative then foreign currency is depreciated.

January 01 1 € = 80C

March 01 1€ = 75C

Exchange rate is quoted in two ways one is direct quote and second is indirect quote. Direct quote is mentioned where one unit of foreign currency is mentioned for the total domestic currency. In the given exchange rate US is domestic currency and it is direct quote for US.

Appreciation/ Depreciation = (75C - 80C) / 80C = -6.25%

Here Euro ( foreign currency is depreciated) and Dollar ( Domestic currency ) is appreciated over the period as compare to euro.

Exercise 02.

Purchase agent from domestic firm ( US) and buying form European market then total amount paid in Dollar if the total amount of transaction is €500,000.

In January = 1euro = 80C ( €500,000 * 80C) = $400000

In March = 1euro = 75C ( €500,000 * 75C) = $375000

If we already knew about the expenditure in January and expenditure is not taken place till march then to hedge against the risk of foreign exchange various measures can be taken such as Forward contracts, Futures and options contracts, Over the counter contracts with banks etc.

Rahul Sunny answered 1 year ago

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