Question Details

Would your business be more exposed to exchange rate risk 


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.
If you decide to implement a major marketing campaign in Mexico, you will incur high expenses in
Mexican pesos. You would need to finance the cost of your marketing. You could either borrow
dollars at a low interest rate and convert them to Mexican pesos to cover the cost, or borrow Mexican
pesos to cover the cost. You would expect to pay off the loan on a monthly basis over the next year
with the use of a portion of the revenue you generate from your business in Mexico.
a. Would your business be more exposed to exchange rate risk if you borrow dollars or Mexican
pesos?
b. Explain how you would make the decision to borrow dollars versus Mexican pesos. What is
the key factor (other than the interest rate of each currency) that will determine whether you
should borrow dollars or Mexican pesos?



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