Question

1-Given the factors that affect the value of a foreign currency, describe the type of economic or other conditions in Mexico that could cause the Mexican peso to weaken, and therefore to adversely affect your business.

2-Explain how currency futures could be used to hedge your business in Mexico. Explain how currency options could be used to hedge your business in Mexico.

a. Explain how your business would likely be affected (at least in the short run) if the central bank of Mexico intervened in the foreign exchange market by exchanging Mexican pesos for dollars in the foreign exchange market.

b. Explain how your business would likely be affected if the central bank of Mexico used indirect intervention by lowering Mexican interest rates (assume inflationary expectations have not changed).

Answer 1

1. Any factors that would cause Mexico peso to weaken would cause concern, given that the business periodically converts pesos into dollars. For example, higher Mexican inflation, or lower Mexican interest rates might cause worry. In addition, speculative flows out of Mexico may result in depreciation of the peso.

2. Mexican peso futures can be sold to hedge the expected monthly profits in Mexican pesos that would have to be converted into dollars.

Mexican peso put options can be purchased to hedge the expected monthly profits in Mexican pesos that would have to be converted into dollars.

a. This form of direct intervention places downward pressure on the peso, which would adversely affect the business.

b. Lower interest rates would cause a reduced demand for interest-bearing securities denominated in pesos, place downward pressure on the peso and would adversely affect the business.