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Question 1: Grexit or Not?
Required reading: Chapter 2, Eun and Resnick
When the euro was introduced in 1999, Greece was conspicuously absent from the list of the EU member countries adopting the common currency. The country was not ready. In a few short years, however, European leaders, probably motivated by their political agenda, allowed Greece to join the euro club in 2001 although it was not entirely clear if the country satisfied the entry conditions. In any case, joining the euro club allowed the Greek government, households, and firms to gain easy access to plentiful funds at historically low interest rates, ushering in a period of robust credit growth. For a while, Greeks enjoyed what seemed to be the fruits of becoming a full-fledged member of Europe. In December 2009, however, the new Greek government revealed that the government budget deficit would be 12.7 percent for 2009, not 3.7 percent as previously announced by the outgoing government, far exceeding the EU’s convergence guideline of keeping the budget deficit below 3.0 percent of the GDP. As the true picture of the government finance became known, the prices of Greek government bonds began to fall sharply, prompting panic selling among international investors, threatening the sovereign defaults.
Several years into the crisis, the Greek government debt stands at around 180 percent of GDP and the jobless rate among youth is above 50 percent. The country’s GDP declined by about 25 percent. Severe austerity measures, such as sharply raised taxes and much reduced pension benefits, were imposed on Greece as conditions for the bail- outs arranged by the EU, IMF, and the European Central Bank. In addition, people were allowed to have only restricted access to their bank deposits, to prevent bank runs. Opin- ion polls indicate that the majority of people in Germany, the main creditor nation for Greece, prefer the Greek exit from the euro zone, popularly called Grexit, while some people in Greece are demanding Grexit themselves and restoration of the national cur- rency, the drachma.
Discuss the following points:
- What were the socioeconomic issues that caused the economic crisis in Greece in 2010?
- Through the 2010 crisis, what do you think were the costs and benefits of staying in the euro zone for Greece?
- What would be the measures that need to be taken to keep Greece in the euro zone in the long run?
- Would you advise Grexit or not? Why or why not?
Question 2: a2 Milk Ltd Pty.
Required reading: Chapters 5, Eun and Resnick (Textbook)
a2 Milk is an Australian company specialising in producing fresh milk and milk formula. The company has its operations in Australia. Therefore, there expenses are generally invoiced in Australian dollars (AUD). However, it has recently imported supplies from New Zealand, and the bill is invoiced in the New Zealand dollars (NZD) for NZD 1,500,000, payable in 6 months’ time.
Suppose a2 Milk’s management is concerned about foreign exchange rate exposure, and would like to hedge this risk. Suppose also that you observe the following quotes in the foreign exchange market:
| Currency | In USD | Per USD | |
| AUD | Spot | 0.7289 | 1.3719 |
| 1-month forward | 0.7280 | 1.3736 | |
| 3-month forward | 0.7264 | 1.3767 | |
| 6-month forward | 0.7242 | 1.3808 | |
| NZD | Spot | 0.6759 | 1.4795 |
| 1-month forward | 0.6763 | 1.4786 | |
| 3-month forward | 0.6785 | 1.4738 | |
| 6-month forward | 0.6800 | 1.4706 |
The banker offers to set up a forward hedge based on the NZD/AUD forward cross-exchange rate implicit in the forward rates against the dollar.Suppose you are a risk manager at a2 Milk.You are required to advise the CEO the following:
- The AUD equivalent of this transaction at the current spot exchange rates.
- The foreign exchange rate risk exposure of this transaction.
- Whether the company should hedge. If so, show the CEO how you would hedge this risk exposure with the available forward contracts.
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