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Ammons-G-M3-A1 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.
Step 1:The net profitability effect on the Mexican firm is the difference between the number of Euro the 1500 pieces of artwork cost at the time of signing the contract and when the payment was made for the artwork. Since the Mexican peso has strengthened, the net profitability is positive. The Italian firm has- to pay more Euros to buy the pesos required for the purchase of 1500 artwork.
The international market concept demonstrated in this example is that fluctuations in foreign exchange rates can lead to either profits or losses for the exporters/importers depending on the direction of the fluctuation.
Step 2
The risks associated with changing exchange rates and international commerce are the effect rate fluctuation can have on a company’s obligation to make or receive payments denominated in foreign currency. The risk currency rate fluctuations can have on a company’s consolidated financial statements if the company is using a foreign subsidy, and impact of unexpected exchange rate changes on the company’s foreign operations cash flows and market value. Also; when a firm makes a bid for a foreign project there is a contingent risk of foreign exchange rate fluctuation.
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icole Clement posted Dec 21, 2018 1:19 AM SubscribeThis page automatically marks posts as read as you scroll.Adjust automatic marking as read setting
Hello Class!
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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.
The net profitability effect on the Mexican firm is that it could lose money in the short-term time-frame of 120 days. The international market concept shown in this example is the foreign exchange market. Foreign exchange market allows the converting of currency from one country to another. When converting money there is an exchange rate. The exchange rate is determined by how the currency is converted over (Euro-currency, 2018). For example, $1.00 United States Dollar (1 USD) equals .87 European Monetary Unit (.87 euro).
In the scenario, there is a time-frame of 120 days but no set date to when the art work is delivered. The exchange rate could change during the 120 days. The exchange rate has a potential to decrease and loose a large amount of profit. If both firms were to forward exchange, then only one firm would come out with a leading profit. An advantage to the forward exchange is there is a set date to exchange (Hill & Hult, 2014). Having a set date would make the exchange feel less like a gamble on who gets the winning profit.
Cost investors will be familiar with the concept of currency exposure, with constantly changing exchange rates affecting the cost of investing in international stocks. These same issues also affect companies that operate internationally. So what effect do currency fluctuations have on company profits, and what are they doing to insulate themselves? In this extract from the Modern Wealth Management blog, we take a look at this issue.
Dealing with currency fluctuations on company profits will always be unpredictable. Companies can better protect themselves by carefully signing clauses on contracts that reduce exposure (Hill & Hult, 2014). Some international organizations will agree on setting all contracts in their own core currency; this way the company will always be paid around the same amount. Another option would be to purchase currency in advance if the organization is planning on making a large purchase and are concerned about volatility (Euroinvestor, 2012). Saving enough liquid assets (if the company can afford to do so) seems to be the smarter way to go when facing such unpredictable currency fluctuations in international business. This way the company can exchange rates ahead of time when the rate of exchange is in present time (Argosy University, 2018).

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