Question Details

What does this imply about the forward premium 



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. What does this imply about the forward premium or discount of the Mexican peso?
b. What does this imply about your business using the forward or futures contracts to hedge your
periodic profits in pesos that must be converted into dollars?
c. Do you think you would frequently hedge your exposure to Mexican pesos? Explain your
answer.



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