Week 9: Real World Applications 8

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?

The Bank of England has been steadily increasing interest rates. This has been done w the goal of preventing further inflation, this comes with the risk of enterprises cutting back on their investments. This rise in interest rates in the UK means that it will be increasingly difficult for potential buyers to take a loan for a new car. To combat this, Daewoo should lower prices to close the gap formed by high interest rates.

• 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 against the dollar. This means that Daewoo would be losing the difference between the pound and the dollar, lowering their profit margin. If this trend continues, it would make sense for Daewoo to increase their sales in the US or increase their volume in the UK.

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 UK and sold them to the US, they would need to increase their prices. This is because inflation would lead to an increase in production cost, this along with the pound being worth less than the dollar would further cut into their profits.