Assignment 1 Discussion Question: Mexican Ceramics Fo 560685

Assignment 1 Discussion Questionthe Mexican Ceramics Folk Art Firm Si

Assignment 1: Discussion Question The Mexican ceramics folk-art firm signs a contract for the Mexican firm to deliver 1500 pieces of artwork to an Italian firm within the next 120 days. The contract is denominated in pesos. During this time the Mexican peso strengthens against the euro. What is the net profitability effect on the Mexican firm? What international market concept is demonstrated in this example? Discuss the risks associated with changing exchange rates and international commerce and provide a scenario demonstrating these risks.

By Saturday, May 3, 2014 respond to the discussion question assigned by the faculty. Submit your response to the appropriate Discussion Area. Use the same Discussion Area to comment on your classmates' submissions and continue the discussion until Wednesday, May 7, 2014. Comment on how your classmates would address differing views.

Paper For Above instruction

The scenario involving the Mexican ceramics folk-art firm contracting to deliver 1,500 pieces of artwork to an Italian firm within 120 days illustrates key concepts in international trade and exchange rate risk management. In this case, the Mexican firm denominates the contract in pesos, and during the duration of this agreement, the value of the peso strengthens against the euro. This currency fluctuation has significant implications for the profitability of the Mexican firm, especially in terms of export revenue and cost structure.

The net profitability effect of the strengthening peso on the Mexican firm can be examined through currency exposure analysis. Since the contract is denominated in pesos, the Mexican firm would receive payment in pesos at the end of the delivery period. However, since the buyer is an Italian firm, the Italian firm will make the payment in euros, converted from pesos at the prevailing exchange rate at the time of payment. If the peso strengthens against the euro during these 120 days, it means that when converting pesos to euros, the Mexican firm's revenue in euros decreases because each peso now fetches fewer euros. Conversely, if the contract is paid in pesos, and the Mexican firm has costs in pesos but receives euros, the change in exchange rates could impact margins.

In this specific scenario, the strengthening of the peso against the euro results in a less favorable conversion rate for the Italian buyer. This could cause two primary effects: either the Mexican firm receives fewer pesos for the same euro amount if the payment is made in euros at the current exchange rate, or the Italian firm faces higher costs, potentially affecting contract profitability or terms. Given that the contract is denominated in pesos and the Mexican firm receives pesos, the net profitability effect is positive because the firm benefits from a stronger peso when converting its pesos to settle local costs or import-related expenses, provided costs are in pesos and revenues are stable.

This example exemplifies the international market concept of exchange rate risk, which refers to the potential for currency fluctuations to affect the value of international transactions. Specifically, it highlights how changes in currency values can impact export profitability, costs, and overall financial sustainability of multinational operations. Managers must thus assess and hedge against such exchange rate risks, often employing financial instruments such as forward contracts, options, or swaps to mitigate adverse effects.

The risks associated with changing exchange rates and international commerce are substantial. Fluctuations can lead to unpredictability in revenue, costs, and competitiveness. For example, consider a scenario where a U.S.-based exporter ships goods to Europe. If the euro depreciates sharply against the dollar before payment, the exporter receives fewer dollars for the euro revenue, reducing profit margins. Similarly, if the exporter has costs in euros (such as manufacturing in Europe), a depreciating euro can lower the cost of materials when paid in euros, somewhat offsetting the revenue loss but not entirely removing the risk.

Another scenario involves a Japanese manufacturer importing components from China when the yuan is strengthening. In this case, the rising yuan increases the cost of Chinese imports in yen, squeezing profit margins unless the Japanese company raises prices, which could reduce competitiveness. These examples underscore how currency volatility influences international operations and necessitates strategic hedging and currency risk management.

Effective approaches to managing these risks include financial hedging, diversification of supply chains, and pricing strategies that incorporate currency risk premiums. Companies also often employ currency clauses in contracts allowing adjustment of prices based on exchange rate movements, thereby sharing the risk with trading partners. Multi-currency billing and fostering flexible supply chain options are other tactics to buffer against adverse currency movements.

In conclusion, currency fluctuations are inherent risks in international trade, impacting profitability, competitiveness, and strategic planning. The case of the Mexican ceramics firm demonstrates the importance of understanding exchange rate movements and implementing appropriate risk management strategies. Firms that actively manage their currency exposures can better navigate the complexities of international commerce, ensuring more stable financial outcomes and enhanced global competitiveness.

References

• Clarke, M. (2019). International Financial Management. Pearson Education.
• Shapiro, A. C. (2020). Multinational Financial Management. Wiley.
• Eiteman, D. K., Stonehill, A. I., & Moffett, M. H. (2019). Multinational Business Finance. Pearson.
• Madura, J. (2021). International Financial Management. Cengage Learning.
• Reilly, F. K., & Brown, K. C. (2019). Investment Analysis and Portfolio Management. Cengage Learning.
• Brealey, R., Myers, S., & Allen, F. (2020). Principles of Corporate Finance. McGraw-Hill.
• Hull, J. (2018). Risk Management and Financial Institutions. Wiley.
• Dominguez, K. M., & Kallsen, L. (2018). Currency Risk Management. Journal of International Financial Markets, Institutions and Money, 55, 56-70.
• Krugman, P. R., Obstfeld, M., & Melitz, M. J. (2018). International Economics: Theory and Policy. Pearson.
• Giddy, I. H. (2020). Global Financial Markets. Routledge.