Hans Brinker is assistant vice-president for marketing for Skagen Ice Skate Company (SIS). SIS does all of its own manufacturing in Denmark and then distributes worldwide through its sales office. World prices for foreign sales offices are set by the home office. Brinker is now setting the price list for all U.S. sales offices, and needs prices set for the coming year. The current spot rate is ?? = ???? $ = 5.6050, with a one-year forward rate of ?? = ???? $ = 5.5685. The one-year deposit rates for Danish krone and U.S. dollars are 1.5% and 1.35%, respectively. SIS’s best-selling professional figure skate, the Royal Silver Blade, is currently priced at $450 to U.S. retailers. Current inflation estimates for Denmark and the United States are both about 3%. SIS’s policy is to try to absorb about 50% of all exchange rate-induced price increases, but pass along 100% of all exchange rate price decreases if possible. The world skate business is competitive. Brinker phones you and explains that he will be on a business trip next week, and you will therefore be responsible for setting the U.S. dollar prices for the coming year. Explain how you will go about setting the price for the Royal Silver Blade. First confirm that Covered Interest Rate Parity does not hold, i.e. the combination of the spot, forward, and interest rates are inconsistent with Covered Interest Rate Parity. What opportunity does this offer for the company in setting the dollar price while hedging exchange rate risk from selling in foreign currency, in this case the U.S. dollar?
Hans Brinker is assistant vice-president for marketing for Skagen Ice Skate Company (SIS). SIS does all of its own manufacturing in Denmark and then distributes worldwide through its sales office. World prices for foreign sales offices are set by the home office. Brinker is now setting the price list for all U.S. sales offices, and needs prices set for the coming year. The current spot rate is ?? = ???? $ = 5.6050, with a one-year forward rate of ?? = ???? $ = 5.5685. The one-year deposit rates for Danish krone and U.S. dollars are 1.5% and 1.35%, respectively. SIS’s best-selling professional figure skate, the Royal Silver Blade, is currently priced at $450 to U.S. retailers. Current inflation estimates for Denmark and the United States are both about 3%. SIS’s policy is to try to absorb about 50% of all exchange rate-induced price increases, but pass along 100% of all exchange rate price decreases if possible. The world skate business is competitive. Brinker phones you and explains that he will be on a business trip next week, and you will therefore be responsible for setting the U.S. dollar prices for the coming year. Explain how you will go about setting the price for the Royal Silver Blade. First confirm that Covered Interest Rate Parity does not hold, i.e. the combination of the spot, forward, and interest rates are inconsistent with Covered Interest Rate Parity. What opportunity does this offer for the company in setting the dollar price while hedging exchange rate risk from selling in foreign currency, in this case the U.S. dollar?
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