This case requires students to consider business and political risks associated with international business operations. It requires them to use techniques illustrated in the chapter to solve basic but realistic foreign exchange problems. Finally, it requires practical application of hedging and risk management techniques discussed in the chapter.
1. In the summer of 2011, a budget crisis in Greece sparked occasionally violent protest demonstrations in Athens. A few weeks later, a right wing extremist in Norway bombed government buildings in Oslo and then went on a shooting spree, killing sixty-nine young campers. In early August, violent riots broke out in London after police shot and killed twenty-nine year old Mark Duggan while attempting to arrest him. Shortly before the start of the fall term, anxious families withdrew more than a third of the students enrolled in UK programs and requested full refunds, even though their contract with Scholastic Travel specified a 50% refund for withdrawals after June 30. Scholastic Travel also faced a higher than normal withdrawal rate from other programs in Western Europe.
a. What types of risk are illustrated by this incident?
b. How should Scholastic Travel respond to the requests for refunds?
2. Ashley and Michaela are participating in a Scholastic college program in Turin, Italy. On a weekend trip to Switzerland, they stop at an outdoor café for coffee and pastry and to and observe the Geneva sidewalk scene. The two cafes au lait and two chocolate croissants came to 19.25 Swiss francs. Because they had not had a chance to exchange any currency, they ask if they can pay in euros or dollars. The server says the price will be the same either way, $14.50 or 10.26 euros.
a. What exchange rates between dollars and Swiss francs and dollars and euros are implied by these prices?
b. What is the implied cross rate between euros and Swiss francs?
c. The actual exchange rates at the time were $1.00 equals €.705 or SF 1.374. Why might these rates differ slightly from the rates calculated in question a?
d. Should Ashley and Michaela pay in dollars or euros?
e. At a Starbucks in the Boston, Massachusetts, suburb of Newton, Ashley and Michaela’s home town, a latte costs $3.50 and a chocolate croissant costs $2.50. If these orders are close substitutes for what they ordered at the Swiss café, does purchasing power parity prevail? Why or why not? Is arbitrage possible?
3. On February 1, 2011, Scholastic received $25,000 in fees from students for a summer program in Angers, France. Directly related to these fees, Scholastic will have to pay €3,525 for facilities rental on June 1 and €7,050 in staff salaries at the end of August. The current exchange rates are the same as in question 2. The future inflation rate in France is estimated at .124% per month; the future U. S. inflation rate is estimated at .231% per month.
a. What is the expected exchange rate on June 1 and on August 31 (use 5 months and 7 months to compute the forward rates)?
b. What is the cost of rents and salaries in dollars at the current exchange rate?
c. What will be the cost of rents and salaries in dollars if expected exchange rates equal actual exchange rates?
d. What will be the cost of salaries in dollars if the dollar unexpectedly strengthens to €.70 or weakens to €.60? What do your answers imply about transaction risk?
4. What measures can Scholastic Travel take to protect the business from exchange rate risk?