Financial Risk Manager Part 1
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A German-based company manufacturing sporting goods relies on a Mexican factory for all the metal components required to assemble collapsible kayaks. Banco de Mexico has recently enacted a monetary policy fostering continuous economic growth and a significant drop in inflation rates. Relevant economic data include:
- Post-policy implementation inflation rate in Mexico: 3.5%
- Pre-policy implementation inflation rate in Mexico: 4.9%
- Inflation rate in Germany: 1.3%
- Exchange rate of EUR to MXN prior to policy implementation: 24.8
What can the manufacturer accurately deduce regarding the impact of the policy shift on their operations?
Exam-Like
A
The price to the consumer will decrease based on purchasing power parity, making the kayak parts less expensive to the German manufacturer.
B
The price to the consumer will increase since lower inflation leads to MxN currency appreciation, making the kayak parts more expensive to the German manufacturer.
C
It cannot be concluded that the price to consumer will increase just from the fact that the monetary policy changes.
D
Lower inflation leads to MXN currency depreciation, making the kayak parts more expensive to German manufacturer,leading to the need to increase prices on finished kayaks to consumers.
Explanation:
Explanation C is correct. There is not a linear dependency between changes in exchange risks and changes in the price of products. This is an example of transaction risk and while the parts become more expensive for the German manufacturer, there are other parameters that affect the price of the kayak, so we cannot conclude that the price to consumer will increase. A is incorrect. Rates change frequently, but this does not mean the price of the products change as often. B is incorrect for the same reason as A. D is incorrect. Lower inflation leads to currency appreciation.
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