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?
High inflation rates led the Bank of England to increase interest rates. The purpose of the policy move is to fight inflation; the higher the inflation rate, the more likely interest rates are to rise. If interest rates rise fast enough, it can lead to a recession. This would negatively impact Daewoo’s profits causing them to sell their cars for higher and purchase materials for more. This a good example of why it’s important to monitor interests rates at the central bank. To reduce the risk of operating in foreign markets is diversification; spread the risk to other countries, not just in one place.
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 is decreasing in value against the U.S. dollar meaning that Daewoo’s would receive less profits. This could lead to a significant financial crisis. The company should increase their prices to make up for this loss or sell in places with better value against the U.S. dollar. This is a good example of why it is important to pay attention to foreign exchange rates.
What if, instead, Daewoo made cars in the U.K. to sell in the U.S. market? How would your answer above change? Elaborate.
This will make overseas profits translate into more dollars rather than fewer dollars and changing the probability of overseas operations. Daewoo would benefit from selling to the U.S. market because he would make greater profits in the long run although it may cost more to produce cars in the UK. With the depreciating value of the pound it would make more sense to sell into the U.S. and sell the cars for higher prices. Monetary policy is also more stable in the US than it is in other countries.