MidTech is a multinational U.S.A. company that performs diverse activities. It manufactures electronic tools like hand-held digital electronic veniers, digital multimeters, voltage testers etc.

To conduct this manufacturing they import certain electronic components from countries like Japan and South Korea.

The market for the manufactured tools are the U.S.A, Australia, Canada and United Kingdom (U.K). However, the majority of sales is in the U.K. Therefore, the company has already put up a subsidiary in the U.K. It resells and distributes the products to different businesses. The quarterly net profit after tax generated by the subsidiary is500,000.The exports to Canada and Australia are to other independent distributing companies that buy the tools at wholesale prices from MidTech.

The company is currently also considering the manufacturing of other hand-held tools like electric drills, circular saws, electric grinders and electric cutters. Market research shows that the main market for those products will be the African continent. Based on this research, MidTech sent you to South Africa to investigate and research the establishment of a manufacturing plant there. The reason for this is that MidTech expects that the manufacturing costs will be much less in South Africa, due to lower labour costs and also lower overhead expenses, than in the U.S.A. Whilst you were conducting the research, you also had discussions with government officials and central bank representatives in South Africa. It became evident that South Africa will be extremely satisfied if the electric tools could be manufactured there, since it will have a positive impact on the Gross Domestic Product of the country when the products can be exported to other African countries. After these discussions, you were also approached by the chief executive of Electo Co. which is an existing electronic component manufacturer in South Africa. According to him, he is willing to enter into an alternative agreement with MidTech. He mentions that Electo Co. also wants to manufacture the electric tools, but in order to prevent competition between Electo Co and MidTech, he believes they can enter into an agreement that could benefit both entities. He came up with the following proposal:

• MidTech provides Electo with the capital to put up the production plant for the electric tool manufacturing plant. The reason is they do not have to put up a complete new plant. The existing electronic component plant can be expanded to facilitate the manufacturing of the tools. Furthermore, the existing infrastructure of Electo Co. in terms of markets in other African countries, trained production staff etc. already exist. Thus, less capital will be required. If it is a new production plant, it will cost ZAR150,000,000. If it is an expansion of the existing plant, it will cost ZAR120,000,000.
• In return, MidTech can benefit from obtaining a 30% shareholding in both the electronic component manufacturing and the electronic tool manufacturing divisions of Electo Co. This will provide MidTech a multinational investment with an estimated net profit after tax of ZAR2, 000,000 per month and also provide MidTech with the opportunity to replace some of its other electronic component imports from Japan, China and Korea. This implies that the capital cost of ZAR120,000,000 will be recovered in 60 months.

The investigating team informed Electo Co. that the proposal will be considered.

After your return from the trip to South Africa, the Chief Executive Officer (CEO) of MidTech, requests the following additional information to assist him with determining the extent of exchange rate risk and the availability of funds to conduct the multinational transactions:

1. The CEO requires a forecast of the one year and two year exchange rates for the $/ calculated based on purchasing power parity (PPP) and with the International Fisher Effect (IFE) with the following existing available information:

Current $/spot exchange rate	$1.3036/
Expected annual U.S. inflation	0.37%
Expected annual British inflation	0.20%
Expected U.S. one-year interest rate	0.140%
Expected British one-year interest rate	0.077%

The CEO requires a forecast of the one year and two year exchange rates for the $/ calculated based on purchasing power parity (PPP) and with the International Fisher Effect (IFE).

Calculate the one year forward$/ exchange rate based on PPP in the space provided below: (2 marks)

Calculate the two year forward$/ exchange rate based on PPP in the space provided below: (2 marks)

Calculate the one year forward$/ exchange rate based on IFE in the space provided below: (2 marks)

Calculate the two year forward$/ exchange rate based on IFE in the space provided below: (2 marks)

Explain the conditions under which the forward exchange rates calculated by you will be unbiased predictors of the future spot exchange rate. Use the space provided below.(2 marks)