None of our client companies operate in a foreign country. They don’t sell into a foreign market. Nor do they manufacture in a foreign market. So we will use a hypothetical manufacturing company, Daewoo, for the assignment.
Daewoo is an American automobile manufacturing company that makes cars in the U.S. and sells in the U.K. market. Assume that a majority of its revenue comes from the U.K. market. Read the attached article, and answer the following questions.
Monetary Policy: Did the Bank of England increase or decrease interest rates? What is the purpose of the policy move, and what is its risk? How would it impact Daewoo’s profits? What should the company do?
Yes, the Bank of England did increase interest rates. The reason behind it was “to try keep high inflation from being embedded in the nation’s economy.” There is the “risk of a ‘more extended and costly tightening cycle later,’ arguing that there were already more persistent inflationary pressures and that expectations for future price increases remained high.” This will impact Daewoo’s profits as they may cause a decrease in sales with higher interest rates as it might be harder for customer to buy it’s vehicles. Or they maybe turn away from making the purchase with paying a higher interest rate then they would have liked to before. With higher interest rates people and company’s buying power gets decreased. The company should start to slow production slightly, and hold off on new projects which might be capital intensive.
Foreign Exchange Risk: Is the British Pound increasing or decreasing in value against the U.S. Dollar? What would that mean for Daewoo’s profits? What should the company do?
The British “pound has fallen to its weakest level against the dollar since 1985”. Well this means that Daewoo is that it’s profits would be decreasing as they are in to the British Pound which is decreasing in value to us the USD. They should raise the price of their vehicles so they don’t loose any profit to the falling price of the pound compared to the US dollar.
What if, instead, Daewoo made cars in the U.K. to sell in the U.S. market? How would your answer above change? Elaborate.
If Daewoo made cars in the U.K. to sell in the U.S. market my answer above would change quite a lot. So by selling cars in the US Daewoo would gain on how the US dollar is increasing in value compared to pound and thus having more buying power. I don’t think I would feel a need to change the prices of my cars or if anything I’d try to focus more on output rather as you are receiving more profit per vehicle.