CASE one Mexico’s Balance-of-Payments Problem Mexico experienced large-scale trade deficits, depletion of foreign reserve holdings, and a major currency devaluation in December 1994, followed by the decision to freely float the peso. These events also bro

CASE one Mexico’s Balance-of-Payments Problem Mexico experienced large-scale trade deficits, depletion of foreign reserve holdings, and a major currency devaluation in December 1994, followed by the decision to freely float the peso. These events also brought about a severe recession and higher unemployment in Mexico. Since the devaluation, however, the trade balance has improved. Investigate the Mexican experiences in detail and write a report on the subject. In the report, you may: 1. Document the trend in Mexico’s key economic indicators, such as the balance of payments, the exchange rate, and foreign reserve holdings, during the period 1994.1 through 1995.12. 2. Investigate the causes of Mexico’s balance-of-payments difficulties prior to the peso devaluation. 3. Discuss what policy actions might have prevented or mitigated the balance-of-payments problem and the subsequent collapse of the peso. 4. Derive lessons from the Mexican experience that may be useful for other developing countries. In your report, you may identify and address any other relevant issues concerning Mexico’s balance-of-payments problem. International Financial Statistics published by the IMF provides basic macroeconomic data on Mexico. CASE 2 Shrewsbury Herbal Products, located in central England close to the Welsh border, is an old-line producer of herbal teas, seasonings, and medicines. Its products are marketed all over the United Kingdom and in many parts of continental Europe as well. Shrewsbury Herbal generally invoices in British pound sterling when it sells to foreign customers in order to guard against adverse exchange rate changes. Nevertheless, it has just received an order from a large wholesaler in central France for £320,000 of its products, conditional upon delivery being made in three months’ time and the order invoiced in euros. Shrewsbury’s controller, Elton Peters, is concerned with whether the pound will appreciate versus the euro over the next three months, thus eliminating all or most of the profit when the euro receivable is paid. He thinks this an unlikely possibility, but he decides to contact the firm’s banker for suggestions about hedging the exchange rate exposure. Mr. Peters learns from the banker that the current spot exchange rate in €/£ is €1.4537; thus the invoice amount should be €465,184. Mr. Peters also learns that the three-month forward rates for the pound and the euro versus the U.S. dollar are $1.8990/£1.00 and $1.3154/€1.00, respectively. The banker offers to set up a forward hedge for selling the euro receivable for pound sterling based on the €/£ forward cross-exchange rate implicit in the forward rates against the dollar. What would you do if you were Mr. Peters?