FINS3616 Lecture Notes - Lecture 6: Marketing Management, Speculative Attack, Foreign Exchange Market
5 – Measuring and Managing Real Exchange Risk
Real profitability of an exporting firm
• Real profitability: the purchasig poer of a fir’s oial profits
• US fir’s oial profit = $ revenue US + $ revenue UK – fir’s $ costs
• $ Revenue US = P (A, $) * Q (A, US)
• $ Revenue UK = S ($, £) * P (A, £) * Q (A, UK)
• $ Costs = C (A, $) * [Q (A, US) + Q (A, UK)]
• Relative prices and components of real profit
Divide nominal profit by price level in US: P ($) – the average of current prices
across the entire spectrum of goods and services produced in the economy
Real revenue U.S. =
Note: P (A, $) / P ($) is the relative price of apples in the US
Real costs = [C (A, $) / P ($)] * [Q (A, U.S.) + Q (A, U.K.)]
How real exchange rates affect real profitability
• Revenue: to keep relative prices constant, the firm must ensure that the nominal
price of apples increases at the IU.S., inflation
• Costs: if its nominal average cost per unit increases at IUS, its real average costs are
constant and the Apples Galore’s total real costs are the same when the same
amount is produced
Fir’s reactio to exchage rate chages:
• Real revenue UK =
• Real costs = C (A, $) / P ($) * [Q (A, US) + Q (A, UK)]
• Exchange rate pass-through: how do management respond regarding its pricing
when real exchange rates change
Real exchange risk at exporters, importers and domestic firms
• Real exchange risk – profitability of a firm can change because of fluctuations in real
exchange rates
• The real exchange rate risk of a net exporter: a competitive dilemma
Raise prices – lose market share
Lower prices – lose profits
• Major factor that deteries a fir’s respose
Price elasticity of demand for its product
Measuring real exchange rate risk exposure
• The preset alue of a fir’s profits
Pricing-to-market strategies:
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Document Summary
Divide nominal profit by price level in us: p ($) the average of current prices across the entire spectrum of goods and services produced in the economy. Note: p (a, $) / p ($) is the relative price of apples in the us. Real costs = [c (a, $) / p ($)] * [q (a, u. s. ) + q (a, u. k. )] Real exchange risk at exporters, importers and domestic firms: real exchange risk profitability of a firm can change because of fluctuations in real exchange rates, the real exchange rate risk of a net exporter: a competitive dilemma. Lower prices lose profits: major factor that deter(cid:373)i(cid:374)es a fir(cid:373)"s respo(cid:374)se. Price elasticity of demand for its product. Measuring real exchange rate risk exposure: the prese(cid:374)t (cid:448)alue of a fir(cid:373)"s profits. Pricing-to-market strategies: occurs when a producer charges different prices for the same good in different markets, examples:
