Compnay A, based in New York, imports leather coats from Company B, based in bue

Question

Compnay A, based in New York, imports leather coats from Company B, based in buenos aires, Argentina. Payment is in Argentine pesos. When the peso lost its parity with the U.S. dollar in January 2002, it collapsed in value to Ps4.0/$ by October 2002. The outlook was for a further decline in the peso's value. Since both Company A and Company B wanted to continue their longtime relationship, they agreed on risk-sharing arrangement. As long as the spot rate on the date of an invoice is between Ps3.5/$ and Ps4/$, Company A will pay based on the spot rate. If the exchange rate falls outside this range, they will share the difference equally with Company B. The risk sharing will last for six months, at which time the exchange rate limits will be reevaluated. Compnay A contracts to import leather coats from Compnay B for Ps8,000,000 or $2,000,000 at the current spot rate of Ps4.0/$ during the next si months.

A. If the exchange rate changes immediately to Ps6.00/$, what will be the dollar cost of six months of imports to Compnay A.

B. At Ps6/$ what will be the peso export sales of Company B to Company A?

Explanation / Answer

Solution: A. If the exchange rate changes immediately to Ps6.00/$, what will be the dollar cost of six months of imports to Compnay A. Bottom Top The allowable range of exchange rates is (Ps/$)                 3.50                 4.50 Outside of this range the trading partners will share the extra risk equally. New exchange rate (Ps/$)                 6.00 Allowable exchange rate (Ps/$)                 4.50 Difference to be shared (Ps/$) = 6.00-4.50=                 1.50 Company A's share = 0.5*1.50                 0.75 Company B's share = 0.5*1.50                 0.75 Therefore, Company A will use the following effective exchange rate after risk-sharing: Top of range                 4.50 Company A's share                 0.75 Effective total of risk-sharing = 4.50+0.75 =                 5.25 Assuming that 6 months of imports will still be (Ps)        8,000,000 Effective exchange rate for Company A (Ps/$)                 5.25 Company A's cost in US dollars = 8,000,000/5.25 = $1,523,809.52 However, the lower cost of importing might lead to higher Company A' sales and therefore a higher import total than Ps 8 million. B. At Ps6/$ what will be the peso export sales of Company B to Company A? The export sales of Company B would remain at Ps 8 million, unless the lower dollar cost encourages Company A to import more from Company B.

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