The United Kingdom still has its own currency, the pound. The pound’s interest rate has historically been higher than the euro’s interest rate. The United Kingdom has considered adopting the euro as its currency. There have been many arguments about whether it should do so.
Use your knowledge and intuition to discuss the likely effects if the United Kingdom adopts the euro. For each of the 10 statements below, insert either increase or decrease in the first blank and complete the statement by adding a clear, short explanation (perhaps one to three sentences) of why the United Kingdom’s adoption of the euro would have that effect.
To help you narrow your focus, follow these guidelines. Assume that the pound is more volatile than the euro. Do not base your answer on whether the pound would have been stronger than the euro in the future. Also, do not base your answer on an unusual change in economic growth in the United Kingdom or in the euro zone if the euro is adopted.
a. The economic exposure of British firms that are heavy exporters to the euro zone would ---------because----------.
b. The translation exposure of firms based in the euro zone that have British subsidiaries would ----------because----------.
c. The economic exposure of U.S. firms that conduct substantial business in the United Kingdom and have no other international business would ----------because---------.
d. The translation exposure of U.S. firms with British subsidiaries would ---------because-------.
e. The economic exposure of U.S. firms that export to the United Kingdom and whose only other international business is importing from firms based in the euro zone would-------- because--------.
f. The discount on the forward rate paid by U.S. firms that periodically use the forward market to hedge payables of British imports would ---------because---------.
g. The earnings of a foreign exchange department of a British bank that executes foreign exchange transactions desired by its European clients would ----------because---------.
h. Assume that the Swiss franc is more highly correlated with the British pound than with the euro. A U.S. firm has substantial monthly exports to the United Kingdom denominated in the British currency and also has substantial monthly imports of Swiss supplies (denominated in Swiss francs). The economic exposure of this firm would-------- because---------.
i. Assume that the Swiss franc is more highly correlated with the British pound than with the euro. A U.S. firm has substantial monthly exports to the United Kingdom denominated in the British currency and also has substantial monthly exports to Switzerland (denominated in Swiss francs). The economic exposure of this firm would------- because----------.
j. The British government’s reliance on monetary policy (as opposed to fiscal policy) as a means of fine-tuning the economy would ---------because---------.