Question Details

What are some limitations on using currency futures 



One of the best methods of learning broad concepts in this text is to put yourself in the place of an
MNC manager or board member, and apply the concepts to make financial decisions. Board members
do not normally make the decisions that are discussed here, but must have the conceptual skills to
monitor the policies that are implemented by the MNC- managers. Thus, they must frequently ask
themselves what they would do if they were making the managerial decisions or setting corporate
polices.
Consider the following business that you could easily create: a business that teaches individuals in a
non-U.S. country to speak English. While this business is very basic, it still requires the same type of
decisions faced by large MNCs. Assume that you initially establish this business in Mexico.
Details of Your Business. You live in the U.S. You invested $60,000 to establish a business of a
language school called EE (Escuela de Engles) in Mexico City, Mexico. You hire local individuals in
Mexico who can speak English and train others how to speak English. You have a small subsidiary in
Mexico, which has an office and an attached classroom that you lease. Clients can come to your
subsidiary for a 1-month structured course in English, taught by your employees. You advertise in the
local newspapers to promote the teaching services offered by your business.
You also serve some individuals from Mexico who have taken English classes and want to come to the
U.S. for a one-week intense course in which they can improve and practice their English and practice
it. All revenue and expenses associated with your business are denominated in Mexican pesos. Most of
the profits from the business in Mexico are sent to you by your subsidiary at the end of each month.
While your expenses are somewhat stable, your revenue varies with the number of clients who sign up
for the English-speaking courses in Mexico.
You only need to know this background so that you can answer the related questions that are asked
about your business throughout the term. Answer each question as if you were serving on the board of
your business or as a manager of the business. The questions in the early chapters force you to assess
the firm- opportunities and exposure, while the later chapters force you to offer your input on
potential strategies that your business may pursue.
1.
Mexican interest rates are normally substantially higher than U.S. interest rates.
a. Assuming that interest rate parity exists, do you think hedging with a forward rate would be
beneficial if the spot rate of the Mexican peso was expected to decline slightly over time?
b. Would hedging with a money market hedge be beneficial if the spot rate of the Mexican peso
was expected to decline slightly over time (assume zero transaction costs)? Explain.
c. What are some limitations on using currency futures or options that may make it difficult for
you to perfectly hedge against exchange rate risk over the next year or so?
d. In general, there is a lack of long-term currency futures and options on the Mexican pesos. A
consultant suggests that this is no problem because you can hedge your position a quarter at a
time. In other words, the profits that you remit at any point in the future can be hedged by
taking a currency futures or options position three months or so before that time. Thus, while
the consultant recognizes that the peso could weaken substantially in the long-term, he sees no
reason why you should worry about it as long as you continually create a short-term hedge.
Do you agree?




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