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OPENING CASE: Subaru’s Sales Boom Thanks to the Weaker Yen
The opening case explores the implications of changing currency values on the U.S. sales of
Japanese automaker Subaru. Prior to 2012, the yen was relatively strong against the U.S. dollar.
Because Subaru had kept most of its production facilities in Japan, it was at a pricing
disadvantage to some of its competitors that maintained production facilities in the United States
and therefore did not have to import vehicles to the North American market. Although this
strategy initially cost Subaru business in North America, a decline in the value of the yen relative
to the dollar beginning in 2012 suddenly made Japanese exports less expensive in the United
States, and Subaru’s sales boomed. Despite the short-term improvement, Subaru decided to
expand its U.S. production facilities as a hedge against future appreciation in the value of the
yen. Discussion of the case can revolve around the following questions:
QUESTION 1: How did the relatively strong value of the yen against the dollar impact the
Japanese economy, and Subaru in particular? How does your response change when the Japanese
yen decreased in value?
ANSWER 1: A strong yen made Japanese exports more expensive for U.S. consumers, which
QUESTION 2: Why would Japan choose to keep its production facilities in Japan prior to 2012?
Was it a good decision to expand U.S. production after 2012?
ANSWER 2: Subaru sought to exploit economies of scale by keeping production local. Its
QUESTION 3: Why did the price of the yen in terms of dollars fall beginning in 2012?
CRITICAL THINKING AND DISCUSSION QUESTIONS
QUESTION 1: The interest rate on South Korean government securities with one-year maturity
is 4% and the expected inflation rate for the coming year is 2%. The U.S. interest rate on
government securities with one-year maturity is 7%, and the expected rate of inflation is 5%.
The current spot exchange rate for Korea won is $1 = W1,200. Forecast the spot exchange rate
one year from today. Explain the logic of your answer.
ANSWER 1: 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.
QUESTION 2: Two countries, Great Britain and the US, produce just one good: beef. Suppose
that the price of beef in the US is $2.80 per pound, and in Britain it is £3.70 per pound.
a. According to PPP theory, what should the $/£ spot exchange rate be?
b. Suppose the price of beef is expected to rise to $3.10 in the US, and to £4.65 in Britain. What
should the one year forward $/£ exchange rate be?
c. Given your answers to parts a and b, and given that the current interest rate in the United
States is 10%, what would you expect current interest rate to be in Britain?
ANSWER 2:
QUESTION 3: Reread the Management Focus on Volkswagen, then answer the following
questions:
a. Why do you think management at Volkswagen decided to hedge only 30 percent of their
foreign currency exposure in 2003? What would have happened if they had hedged 70 percent
of their exposure?
b. Why do you think the value of the U.S. dollar declined against that of the euro in 2003?
c. Apart from hedging through the foreign exchange market, what else can Volkswagen do to
reduce its exposure to future declines in the value of the U.S. dollar against the euro?
ANSWER 3:
a. When Volkswagen decided to hedge just 30 percent of its foreign exchange exposure in 2003,
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
c. In addition to using forward contracts, Volkswagen could use currency swaps, and lead and lag
QUESTION 4: You manufacture wine goblets. In mid-June you receive an order for 10,000
goblets from Japan. Payment of ¥400,000 is due in mid-December. You expect the yen to rise
from its present rate of $1=¥130 to $1=¥100 by December. You can borrow yen at 6% per year.
What should you do?
ANSWER 4: The simplest solution would be to just wait until December, take the ¥400,000 and
QUESTION 5: You are the CFO of a US firm whose wholly owned subsidiary in Mexico
manufactures component parts for your U.S. assembly operations. The subsidiary has been
financed by bank borrowings in the United States. One of your analysts told you that the
Mexican peso is expected to depreciate by 30 percent against the dollar on the foreign exchange
markets over the next year. What actions, if any, should you take?
ANSWER 5: Your financing and operating capital are in dollars, yet many of your costs (labor)
CLOSING CASE: Embraer and the Wild Ride of the Brazilian Real
Summary
The closing case explores the implications of changing currency values on the profits of
Brazilian aircraft manufacturer Embraer, which, like all other firms in the industry, prices its
aircraft in U.S. dollars. Between 2004 and 2008, the value of the Brazilian real against the dollar
more than doubled, which negatively affected Embraer’s profit margins. In order to hedge
against future appreciation of the real, Embraer purchased forward contracts that would allow the
firm to exchange dollars for reals at a specified rate. During the financial crisis of 2008, however,
the value of the real depreciated against the dollar, and the terms of the forward contract were no
longer favorable, leading to a $121 million loss for Embraer. Since then, Embraer has not hedged
against foreign exchange risk and the real has continued to depreciate against the dollar, resulting
in a significant improvement in the firm’s finances. Discussion of the case can revolve around
the following questions.
QUESTION 1: What does the recent economic history of Brazil tell you about the relationship
between price inflation and exchange rates? What other factors might determine exchange rates
for the Brazilian real?
ANSWER 1: During periods of high inflation in Brazil, the value of the Brazilian real has
QUESTION 2: Is a decline in value of the real against the U.S. dollar good for Embraer, bad for
Embraer, or a mixed bag? Explain your answer.
ANSWER 2: In general, a decline in the value of the real against the dollar is good for Embraer.
QUESTION 3: What kind of foreign exchange rate risks is Embraer exposed to? Can Embraer
reduce these risks? How?
ANSWER 3: Embraer is vulnerable to transaction exposure because the profits it earns from
ANSWER 4: Do you think Embraer's decision to try and hedge against further appreciation of
the real in the early 2000s was a good decision? What was the alternative?
ANSWER 4: At the time, Embraer’s decision made sense. The Brazilian government and
QUESTION 5: Since 2008 Embraer has significantly reduced its dollar hedging operations. Is
this wise?
ANSWER 5: Student answers will vary depending on their expectations for the U.S. and
QUESTION 6: Between mid-2014 and early 2015 the real depreciated significantly against the
U.S. dollar. What do you think the impact was on Embraer?
MHE INTERNATIONAL BUSINESS VIDEO LIBRARY
Please click here to visit our International Business Video Library on Pinterest, which is updated
on a monthly basis. While there, be sure to "like" the clips that work well for you, and add notes
that might be helpful to your colleagues.
INCORPORATING globalEDGE™ EXERCISES
Use the globalEDGE™ site {globaledge.msu.edu/} to complete the following exercises:
Exercise 1
One of your company’s essential suppliers is located in Japan. Your company needs to make a 1
million Japanese yen payment in six months. Considering that your company primarily operates
in U.S. dollars, you are assigned the task of deciding on a strategy to minimize your transaction
exposure. Identify the spot and forward exchange rates between the two currencies. What factors
influence your decision to use each? Which one would you choose? How many dollars must you
spend to acquire the amount of yen required?
Exercise 1 Answer
The FXStreet.com website specializes in analyzing the foreign exchange market, including news
and analysis in addition to live exchange rates. Both spot rates and forward rates can be found
under the “Rates & Charts” section.
Search phrase: forward exchange rates
Resource Name: FXStreet.com
Website: http://www.fxstreet.com/
globalEDGE Category: Finance
Exercise 2
Sometimes, analysts use the price of specific products in different locations to compare currency
valuation and purchasing power. For example, the Big Mac Index compares the
purchasing-power parity of many countries based on the price of a Big Mac. Locate the latest
edition of this index that is accessible. Identify the five countries (and their currencies) with the
lowest purchasing-power parity according to this classification. Which currencies, if any, are
overvalued?
Exercise 2 Answer
The Big Mac Index was invented by The Economist in 1986 and has been updated annually since
then to provide a light-hearted demonstration of the theory of purchasing-power-parity by
comparing the price of a Big Mac in various countries around the world.
