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International Financial Environment Case Solution

This document contains answers to 5 questions about how international trade and capital flows would be affected by changes in inflation and interest rates between the UK and US. For question 1, the answer explains that a rise in UK inflation would lead to a higher trade deficit as British exports become more expensive. Question 2 is answered by saying that lower UK inflation would strengthen the British pound relative to the US dollar due to the pound's increased purchasing power. Question 3 discusses how an increase in US inflation and interest rates could put downward pressure on the British pound through their impacts on trade and capital flows. The answer to question 4 indicates that Mesa's cash flows would decrease if the British pound declines in value as expected due

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Kinza Zaheer
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216 views2 pages

International Financial Environment Case Solution

This document contains answers to 5 questions about how international trade and capital flows would be affected by changes in inflation and interest rates between the UK and US. For question 1, the answer explains that a rise in UK inflation would lead to a higher trade deficit as British exports become more expensive. Question 2 is answered by saying that lower UK inflation would strengthen the British pound relative to the US dollar due to the pound's increased purchasing power. Question 3 discusses how an increase in US inflation and interest rates could put downward pressure on the British pound through their impacts on trade and capital flows. The answer to question 4 indicates that Mesa's cash flows would decrease if the British pound declines in value as expected due

Uploaded by

Kinza Zaheer
Copyright
© © All Rights Reserved
We take content rights seriously. If you suspect this is your content, claim it here.
Available Formats
Download as DOCX, PDF, TXT or read online on Scribd
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Case Study Solution:

Question no 1: Explain how the international trade flows should initially adjust in response….?
Answer: In response to changes in inflation the balance if trade deficit should be increased. If
inflation raises the prices of exports then it go high, resulting a downward British demand for
exports. Moreover, if prices increase it lets to increase in the demand for British exports.
In response to lower British interest rates there is a decrease in the capital flows from the U.S to
the U.K, whereas the capital flows from the U.S to the U.K should increase (assuming constant
exchange rates.)
Question no 2: Using the information provided, will mesa expect….?
Answer: As a general rule, a currency with lower inflation is expected to see increase in its
currency values and so, lower inflation in UK will lead to strengthening of pound against US
dollar. Due to fact, lower inflation will increase the purchasing power of pound as compared to
other currencies like US dollar. So, as a result of higher inflation in USA and lower inflation in
UK, the value of pound will appreciate against US dollar.
Question no 3: Mesa believes international capital flows shift in response to change…?
Answer: If the U.K economy is relatively unchanged the increase in U.S inflation will put
pressure on the value of pound because of its impact on international trade. Yet the increase in
U.S interest rates place downward pressure on the value of pound due to its impact on capital
flows. The international capital flow will have to change significantly if interest rate and
inflation were depreciate over the time, this would mean a drop in the capital spending budget,
cash, bonds and stocks as well.
Question no 4: Based on your answer to question 2, how would mesa’s cash flows…?
Answer: Mesa’s cash flows would be affected by exchange rate movement if the inflation rate
and interest rate of the price were to decrease, this decrease would lead to Mesa having
significantly less cash flow than expected. If the value of currency were to drop to a value that is
not set at present time.
Being that pound is estimated to decrease over time shows that MESA will have some form of
cash flow affected by expected change in exchange rate and inflation rate.
Question no 5: Based on your answer to question 4, should Mesa consider hedging its exchange
rate risk…?
Answer: A forward contract would be an agreement between a corporation and financial
institution to exchange a specified amount of a currency at a specified exchange rate on a
specified date in the future. Meaning that Mesa can lock a particular interest rate in order to
guarantee the price would be available to them in the future. By hedging the future contracts but
it is limited to a certain tradable amount. Hedging a currency option would allow Mesa to have
the right to buy a specific currency at a designated price within a specific time period. Mesa
could lock in the top price that the exchange rate for a future return at that same price.
Since it is known that the price of inflation rate and exchange rate is going to drop in the future
all of these options would suffice in Mesa being able to capitalize on the current rate in future
market.
Submitted by: kinza zaheer
BBA 6-C

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