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A 15-minute interactive lesson with Prof. Forest Reinhardt
Exchange Rates' Impact on Business
Section 1 of 15
Introduction
In this lesson, you'll learn about exchange rates—the value of one country's currency in relation to another. You'll explore the difference between real versus nominal exchange rates, forces that drive those rates to change, and the impact currencies can have on international businesses through real examples from leaders at a multinational conglomerate, ski resort, and grocery store chain.
Section 2 of 15
Section 3 of 15
Section 3 of 15
Trading debt based on differences in interest rates between countries is not an academic abstraction. While living in India, Anand Mahindra, chairman of multinational conglomerate Mahindra Group, financed a building in New York using a loan in Israel.
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Section 5 of 15
Section 5 of 15
Thinking about real versus nominal exchange rates can be tricky. Let’s try an example and make sure we can do this.
You work for a company that makes high-grade tires for airplanes, and you import your rubber from a supplier in Thailand. Let’s say that prices in your home country are stable, meaning there’s been no inflation. But, inflation has been 10 percent in Thailand. Meanwhile, the Thai baht has depreciated by five percent against your home currency in nominal terms.
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Has the rubber you’re purchasing become more expensive or cheaper?
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Section 7 of 15
If you guessed that the rubber would be more expensive, you're correct! Prices have gone up by 10 percent, but the change in the nominal exchange rate has only reduced prices by five percent. The net increase in prices for you is five percent. This represents an increase in the real exchange rate.
Now, let's imagine that you're Ellen Guidera and operate a ski resort in Chile. Most of your costs are in pesos in Chile. But most of your guests come from outside the country. If you price in pesos, you can match your revenues to your costs and eliminate currency risk—you only have to worry about filling your resort. Yet, if you do this, your customers take on all of the currency risk. Alternatively, you could price in dollars or some other currency. In that instance, you take on the risk, but your customers have certainty about the price they're paying.
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Which would you do?
Section 9 of 15
Why did you choose to price in pesos or in dollars?
Peer responses
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Section 11 of 15
Section 11 of 15
Suppose instead that you’re Craig Boyan and operate retail grocery stores in the United States and Mexico. Your costs are in US dollars, but the customers in your Mexican stores will pay in pesos, and—unlike Ellen—you can’t just convince them to pay in dollars. If the dollar gets stronger, you’ll be facing increasing costs and decreasing revenue.
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Would you increase prices in Mexico to balance that?
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Section 14 of 15
Section 14 of 15
There are several factors to consider when determining how to charge your customers. Even a small exchange rate change can dramatically impact your business. It’s vital to understand what the implications are so you can effectively manage risk.