Problem 4.

1 Passing through
Steps
Initial spot exchange rate (/US$)
Initial price of a Honda in, in yen
Expected US dollar inflation rate for the coming year
Expected Japanese yen inflation rate for the coming year
Desired rate of pass through by Honda
a. What was the dollar price for a Honda at the beginning of the year?
Year-beginning price of a Honda (in yen)
Spot exchange rate (/US$)
Year-beginning price of a Honda (in US$)
b. What is the expected spot rate one year from now assuming PPP?
Initial spot rate (/US$)
Expected US$ inflation
Expected Japanese yen inflation
Expected spot rate one year from now assuming PPP (/US$)
c. Assuming complete pass through, what will the price be in US$ in one year?
Price of Honda at beginning of year (in yen)
Japanese yen inflation over the year
Price of Honda at end of year (in yen)
Expected spot rate one year from now assuming PPP (/US$)
Price of Honda at end of year (in US$)
d. Assuming partial pass through, what will the price be in US$ in one year?
Price of Honda at end of year (in yen)
Amount of expected exchange rate change, in percent
Proportion of exchange rate change passed through by Honda
Proportional percentage change
Effective exchange rate used by Honda to price in US$ for end of year
Price of Honda at end of year (in US$)

Value
125.00
4,000,000
3.000%
1.000%
60.000%

4,000,000
125.00
$32,000.00

125.00
3.00%
1.00%
122.57

4,000,000
1.000%
4,040,000
122.57
$32,960.00

4,040,000
1.980%
60.000%
1.188%
123.532
$32,704

Problem 4.2 Chilean pesos

Assumptions
Spot exchange rate, one year ago, pesos per US$
Change in value of peso over the year
US inflation over year
Chilean inflation over year

Value
500.00
-25.00%
0.00%
22.00%

a. What is the actual exchange rate today?

Beginning spot rate (pesos/US$)
Percentage change in the peso
Actual exchange rate today (pesos/US$)

500.00
-25.00%
666.67

Check: (Beginning-Ending)/(Ending)

-25.00%

b. What should be the exchange rate today based on PPP?

Beginning spot rate (pesos/US$)
Chilean inflation
US inflation
PPP exchange rate

500.00
22.00%
0.00%
610.00

c. By what percentage is the peso overvalued or undervalued?

Actual exchange rate today (pesos/US$)
PPP exchange rate (pesos/US$)
Percentage overvaluation (positive) or undervaluation (negative)

666.67
610.00
-8.500%

Problem 4.4 Trident borrows euros

Assumptions
Trident is borrowing the following principal, in euros ()
Trident's cost of borrowing euros ()
Interest savings over borrowing rate in the US
Current spot exchange rate (US$/)
Expected US inflation rate for the coming year
Expected euro inflation rate for the coming year

Value
4,000,000
5.000%
3.000%
$0.9000
6.000%
2.000%

Euro borrowing:
Trident borrows the following euros
At the following interest rate
Repaying principal and interest of the following in one year

4,000,000
5.000%
4,200,000

Proceeds of euro loan in US dollars

$3,600,000

Expected spot rate in one year:

Current spot rate (US$/euro)
US inflation rate
euro inflation rate
Expected spot rate assuming PPP (US$/)
Repaying the euro loan in US dollars will cost:
Required repayment in euros
At the following expected spot rate ($/)
Will require this amount of US dollars
Cost of the loan in dollar terms is = (Repayment/Proceeds)-1
This is the real cost of borrowing in euros as Trident would expect.

$0.9000
6.000%
2.000%
0.9353

4,200,000
$0.9353
$3,928,235
9.1176%

Problem 4.9 Langkawi Island Resort

Assumptions
Charge for suite plus meals (in ringgit)
Spot exchange rate (ringgit per US$)
US$ cost today for a 30 day stay

Value
760.00
3.8000
$6,000.00

Malaysian ringgit inflation rate expected to be

U.S. dollar inflation rate expected to be

4.000%
1.000%

a. How many dollars might you expecte to need one year hence for your 30-day vacation?
Spot exchange rate (ringgit per US$)
Malaysian ringgit inflation rate expected to be
U.S. dollar inflation rate expected to be
Expected spot rate one year from now based on PPP (ringgit per US$)

3.8000
4.000%
1.000%
3.9129

Hotel charges expected to be paid one year from now for a 30-day stay

23,712.00

US dollars needed on the basis of these two expectations:

$6,060.00

b. By what percent has the dollar cost gone up? Why?

New dollar cost
Original dollar cost
Percent change in US$ cost

$
$

The dollar cost has risen by the US dollar inflation rate. This is a result of your
estimation of the future suite costs and exchange rate changing in relation to inflation.

6,060.00
6,000.00
1.000%