Quoting for Exports or Projects Currency Fluctuation Considerations

This Assignment or Exercise does not require the use of any textbook or academic research and material. Rather, it seeks to develop the basic quantitative reasoning that is used in making currency decisions while quoting (as a supplier) for the export of a product.

Context to Develop Our Reasoning:

Here let us assume that an American manufacturer wishes to export his product (baseball bats) to a European country. The question that we are asking is: Should the American Exporter Quote for/Invoice the product in Dollars or should he quote in Euros.

The current exchange rate is 1 $ = 0.85 Euros, which implies that 1 Euro = 1.176 Dollars

Now let us make a very normal assumption: The European buyer (being no fool) is very aware of manufacturing costs in USA so in any current negotiations he uses the current manufacturing costs as his base for arriving at a price: He therefore agrees to pay $ 7 for a single bat. Alternatively, he would be ready to pay Euros 5.95 using current exchange rates. The contract is for the sale of 1000 bats by the American exporter. The quoted price per bat can be $7 or Euro 5.95, depending on the currency you choose to transact in.

The contract will take 3 months to execute (it is very normal for international contacts to take time), and by the time the European recipient will receive the bats, 3 months would pass. In these three months, the exchange rate would (quite naturally) change:

Consider two scenarios:

1. The dollar appreciates (gains value relative to the Euro) and after three months 1 $ = 1 Euro
2. The dollar depreciates and after three months 1 $ = 0.50 Euro

If the quotation is in Euros, the American exporter will receive payments in Euros in his own American bank, in keeping with the quotation. The bank will then convert the Euros to Dollars at the prevailing exchange rate at that time. Ultimately the American exporter wants dollars since he wishes to spend money in USA.

If the payment and corresponding quotation is in dollars, then the payment received is in the same value of dollars, anyway.

QUESTIONS

1. For scenario (a) calculate and show: What the exporter loses by quoting in the Euro (remember, that finally, the Euro payments will be converted to dollars, since it is dollars that an American finally uses in America)

(40 points for this question)

2. For scenario (b) calculate and show, what the American exporter gains by quoting in the Euro.

(40 points for this question)

3. Based on questions 1 and 2 can you develop and state any generalized recommended rules regarding which currency should be used while quoting, on the assumption that you can forecast the direction of exchange rate changes (even if you cannot forecast the extent). This means you can guess which currency is going to appreciate or depreciate (even if you cannot forecast exact exchange rates).

(10 points for this question)

4. Suppose there are five currencies, each appreciating or depreciating at different rates, and you had the choice of quoting in ANY currency, which would you choose? Can you suggest a rule to make this choice?

(10 points for this question)