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Note: only blue cells need to be updated with current quotes.
Direct Quote Currencies:
Indirect Quote Currencies:
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United Kingdom 0.7651 0.8906 …. 0.5810 0.0068 0.0405 0.7659
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A B C D E F G H I
Solution 11/26/2018
Chapter: 17
Problem: 15
You will find Tables 17-1 and 17-2 useful for this problem and are shown in following rows.
TABLE 17-1
Exchange rates of select major currencies, relative to the U.S. dollar
Key Currency Cross-Exchange Rates
Note: these do not need to be updated because they are derived from the quotes in preceding table and are not rounded.
U.S. Dollar Euro U.K. Pound CdnDlr Yen Peso SFranc
United States …. 1.1641 1.3071 0.7594 0.0089 0.0529 1.0011
Input Data
Cost of rosewood and mahogany (pesos) 2,750
Cost of spruce (CdnDlr) 200
Mark Collins, luthier and businessman, builds and sells custom-made acoustic and electric stringed instruments. Although located in Maryville, Tennessee, he
purchases raw materials from around the globe. For example, his top-of-the line acoustic guitar with onboard electronics, the MC-28, is constructed from rosewood
and mahogany imported from a distributer in Mexico, spruce harvested in and imported from Canada, and ebony and the electronics imported from a Japanese
distributer. Other parts are obtained in the U.S. When broken down on a per-guitar basis, the component and finishing costs are as follows:
a. How much, in dollars, does it cost for Mark Collins to produce his MC-28? What is the dollar sale price of the MC-28 sold in England?
Note: The pound and euro are quoted as direct quotations. Other currencies are quoted as indirect quotations. Blue denotes the actual quotes, which are reported
out to digits to the right of the decimal; orange is the inverse of the provided quote and is not rounded.
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A B C D E F G H I
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Cost of ebony and electronics in $ = Cost in yen x Direct spot exchange rate ($/yen)
Cost of ebony and electronics in $ = 12,400.00 x 0.0089
Cost of ebony and electronics in $ = $109.89
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The percentage profit is determined as the dollar profit divided by the total cost.
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U.K. (British) pound (£) 1.30710 0.76505 1.4523 0.6885
Canadian dollar ($) 0.75942 1.31680 0.8438 1.1851
Japanese yen (¥) 0.00886 112.84000 0.0098 101.5560
Mexican peso ($) 0.05292 18.89550 0.0588 17.0060
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Cost of rosewood and mahogany in $ = 2,750.00 x 0.0588
A B C D E F G H I
Rosewood and mahogany
Cost of rosewood and mahogany in $ = Cost in pesos x Direct spot exchange rate ($/peso)
Cost of rosewood and mahogany in $ = 2,750.00 x 0.0529
Cost of rosewood and mahogany in $ = $145.54
Spruce
Ebony and electronics
Parts and labor
Cost of parts and labor in $ = Cost in dollars
Cost of parts and labor in $ = 600.00
Cost of parts and labor in $ = $600.00
TOTAL COST OF THE MC-28 (in dollars) = $1,007.31
Revenue from sale of the MC-28 in England
MC-28 SALES PRICE (in dollars) = $2,091.36
b. What is the dollar profit that Collins makes on the sale of the MC-28? What is the percentage profit?
The dollar profit from the sale of the SY-20 is simply the sales revenue minus the total cost.
We will reproduce selected data the table from the top of the spreadsheet, but there are two additional columns for the new exchange rates.
Euro (€) 1.16410 0.85903 1.2934 0.7731
Now, we will recompute the component costs and sales price of the MC-28.
Rosewood and mahogany
Cost of rosewood and mahogany in $ = Cost in pesos x Direct spot exchange rate ($/peso)
-10%
c. If the U.S. dollar were to depreciate by 10% against all foreign currencies, what would the dollar and percentage profits be for the MC-28?
Since dollar is depreciating, a dollar buys fewer units of foreign currency than before its depreciation. Therefore, the indirect quotes (which show the number of
Change in dollar versus all currencies (positive is appreciation, negative is depreciation):
New Indirect
Quotations
(4)
New Direct
Quotations
(3)
Old Direct
Quotations
(3)
Old Indirect Quotations
(4)
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Cost of spruce in $ = Cost in CdnDlr x Direct spot exchange rate ($/CdnDlr)
Cost of spruce in $ = 200.00 x 0.7594
Cost of spruce in $ = $151.88
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Revenue from sale of the MC-28 in England
MC-28 SALES PRICE (in dollars) = $2,323.73
A B C D E F G H I
Cost of rosewood and mahogany in $ = $161.71
Spruce
Cost of spruce in $ = Cost in CdnDlr x Direct spot exchange rate ($/CdnDlr)
Cost of spruce in $ = 200.00 x 0.8438
Cost of spruce in $ = $168.76
Parts and labor
Cost of parts and labor in $ = Cost in dollars
Cost of parts and labor in $ = 600.00
Cost of parts and labor in $ = $600.00
TOTAL COST OF THE MC-28 (in dollars) = $1,052.57
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Ebony and electronics
Cost of ebony and electronics in $ = Cost in yen x Direct spot exchange rate ($/yen)
Cost of ebony and electronics in $ = 12,400.00 x 0.0098
Cost of ebony and electronics in $ = $122.10
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Canadian dollar ($) 0.75942 1.31680 0.75942
Japanese yen (¥) 0.00886 112.84000 0.00886
Mexican peso ($) 0.05292 18.89550 0.05292
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Cost of spruce in $ = Cost in CdnDlr x Direct spot exchange rate ($/CdnDlr)
Cost of spruce in $ = 200.00 x 0.7594
Cost of spruce in $ = $151.88
Ebony and electronics
Cost of ebony and electronics in $ = Cost in yen x Direct spot exchange rate ($/yen)
Cost of ebony and electronics in $ = 12,400.00 x 0.0089
Cost of ebony and electronics in $ = $109.89
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Revenue from sale of the MC-28 in England
MC-28 SALES PRICE (in dollars) = $2,323.73
The dollar profit from the sale of the MC-28 is simply the sales revenue minus the total cost.
Dollar profit = Sales price – Total cost
Dollar profit = $2,323.73 – 1,007.31
Dollar profit = $1,316.42
A B C D E F G H I
The dollar profit from the sale of the MC-28 is simply the sales revenue minus the total cost.
Dollar profit = Sales price – Total cost
Dollar profit = $2,323.73 – 1,052.57
Dollar profit = $1,271.17
Change in dollar strength against the pound -10%
Euro (€) 1.16410 0.85903 1.16410
Now, we will recompute the component costs and sales price of the MC-28.
Rosewood and mahogany
Cost of rosewood and mahogany in $ = Cost in pesos x Direct spot exchange rate ($/peso)
Cost of rosewood and mahogany in $ = 2,750.00 x 0.0529
Cost of rosewood and mahogany in $ = $145.54
Parts and labor
Cost of parts and labor in $ = Cost in dollars
Cost of parts and labor in $ = 600.00
Cost of parts and labor in $ = $600.00
TOTAL COST OF THE MC-28 (in dollars) = $1,007.31
d. If the U.S. dollar were to depreciate by 10% only against the pound and remained constant relative to all other foreign currencies, what would the dollar and
percentage profits be for the MC-28?
Since dollar is depreciating relative to the pound, a dollar buys fewer pounds than before its depreciation. Therefore, the indirect quote for pounds (which shows
the number of pounds per dollar) should be reduced by 10%. Then we convert the new indirect quote to a direct quote (divide 1 by the indirect quote to get the
direct quote). The is no need to change any other direct quotes because the dollar is neither depreciation nor appreciating relative to them.
New Indirect
Quotations
(4)
New Direct
Quotations
(3)
Old Direct
Quotations
(3)
Old Indirect Quotations
(4)
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The percentage profit is determined as the dollar profit divided by the total cost.
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Home nominal interest rate = 3.9%
Foreign nominal interest rate = 5.0%
Time to maturity on securities (in years) = 0.25
Home periodic interest rate = 0.975%
Foreign periodic interest rate = 1.250%
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Exchange rate (pounds per euro) = 0.8906
A B C D E F G H I
The percentage profit is determined as the dollar profit divided by the total cost.
Using knowledge of interest rate parity, the following problem is set up.
Spot exchange rate (direct quotation) = 1.3071
Purchasing power parity allows us to establish the following problem.
Price in pounds = 1,600
e. The rate of return on 90-day U.S. treasury securities is 3.9% and the rate of return on 90-day U.K. risk-free securities is 5.0%. Using the spot exchange
information from Table 17-1, estimate the 90-day forward exchange rate.
f. Assuming that purchasing power parity holds, what would the sale price of the MC-28 be if it were sold in France rather than England? (Hint: assume England is
the home country.)
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