Question

international marketing

The Euro Yo-Yo

Since the inception of the European Monetary Union (EMU) on January 1, 1999, the ups and downs of the euro have created challenges and opportunities for global companies. The euro’s volatility has also compounded the economic problems of the 12 countries in the euro zone. The euro began its life as an electronic medium with an exchange rate set at €1 equal to $1.161. Then, the unexpected happened: The euro’s value plunged relative to the currencies of Europe’s major trading partners. The lowest point came in October 2000, when one euro was worth only about 83 cents. By December, the euro has strengthened to about 97 cents; it then plunged again in mid2001. Euro coins and bills began to circulate on January 1, 2002, after which the euro began to steadily gain strength. By mid-2003, as the war in Iraq and the ballooning deficit raised concerns about U.S. economy, the euro’s value had strengthened to a monthly average of $1.17. The euro’s volatility forces businesses that export to Europe to think carefully about business strategies and policies. One such company is Markel Corp, a Philadelphia-based manufacturer of cable-control tubing and insulated wire used in the automotive and appliance industries. About 40 percent of Markel’s $26 million in sales is generated in Europe; important euro zone customers are located in Spain, the Netherlands and Germany. In an effort to build up market share, company president Kim Reynolds aim to hold prices steady for Markel’s euro zone customers; contracts with euro zone customers call for payment in euros. The strategy is paying off; today, Markel commands about 70 percent of the global market for high-performance tubing. This success came at a cost, however; as the euro plunged in value, Markel’s losses mounted. In 2000, the company suffered a currency loss of $650,000; losses in 2001 and 2002 amounted $400,000 and $225,000 respectively. However, Reynolds hedges his exchange risk by buying forward contracts that guarantee him a set number of dollars for each euro his customers pay. Even so, Reynolds was forced to institute pay cuts for salaried employees and cancel year-end bonuses and dividends to shareholders. The situation has changed dramatically as the euro has gain strength again; in 2003, Reynolds expects a currency gain of up to $500,000. Policy makers in the 12 euro zone nations are also facing challenges. Here too, an analysis of the Euroland economy must begin by addressing issues related to the currency’s volatility. Twelve nations make up Euroland: Germany, France, Spain, Portugal, Luxembourg, the Netherlands, Ireland, Italy, Austria, Finland, Belgium and Greece. Sweden voted in late summer of 2003 to retain the Krona. No doubt the volatility of the euro was a consideration, as was the desire to preserve Sweden’s generous social welfare system. There is more support for the euro in the remaining two holdouts. According to Eurobarometer, an EU public opinion poll, 53 percent of the citizens of Denmark now favour the common currency. By contrast, in the United Kingdom, only 24 percent support a change to the euro. It is possible that both countries will wait until 2006 to put the euro to a vote again. Given the challenges faced by companies such as Markel and the governments in the euro zone, it is fair to ask whether the euro experiment has been a success or a failure. Is there a bright future ahead for the new currency zone or will the old problems of an inflexible labor market and slow growth continue to plague Europe? European economic success will depends on a strong American economy. Trade with the United States will create economic growth in Europe. Increasingly stressed relations resulting from American export tax relief and European Union preferential tariffs work to limit free trade and growth. 2 | P a g e M K T G 3 4 1 0 / J u n e 2 0 2 0 Enlargement of the European Union is sustaining the drive toward open free trade and competitiveness that began with the coal and steel communities, but Europe needs to wake up to the fact that globalization has passed enlargement by. Global capital flows, global sourcing of products and global movement of people are facts of modern economic life. While Europe goes about the business of building its federal nation state, it must also go about the business of building institutions and attitudes that are necessary to accommodate the global market

How forward contract can reduce the risk of currency volatility?

Can Markel ask their customers to pay in other currency which is more stable?.

Answer 1

Ans

Currency Forward Contract is an agreement to buy or sell a currency at a predetermined exchange rate at a future date. This contract is used to hedge against the appreciation or depreciation of currency. For example company A which is expecting to receive payments in Euros after 3 months and has reporting currency in Dollars will sell Euros through a forward contract dated 3 months ahead to fix its dollar earning.

Markel can ask its customer to pay in Dollars which depends on the bargaining power of Markel to reduce the impact of Euro volatility vs Dollar.