The Case of The Drifting Exchange Rate

International Research Journal of Applied Finance ISSN 2229 – 6891
March, 2012 Case Study Series
The Case of the Drifting Exchange Rate
Allen B. Atkins, Ph.D.

Professor of Finance
Northern Arizona University
[email protected]
Roxanne Stell, Ph.D.

Professor of Marketing
[email protected]
Larry Watkins, Ph.D., CPA

Professor of Accounting
[email protected]
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Allen B. Atkins, Northern Arizona University, [email protected]

Case ID 030303
The Case of the Drifting Exchange Rate
Randy Bozarth loosened his grip on the tiller of his sail boat and let the bow turn slowly into the
breeze. Soon the craft nosed into the wind and was virtually dead in the water giving Randy
time to think about what had been troubling him for days now. If only he had taken an
international finance course rather than wasting his time on “fun” electives when in college. But
that was in the past and if he had learned anything so far in life it was you cannot change the
past.
Randy had relocated from the Chesapeake Bay area to the west coast of Mexico a couple of
years earlier to be able to sail more and also to experience a different culture. So far he was
quite happy with his decision although life ‘south of the border’ did present some unique
challenges. Most of the challenges came from his housing arrangements. Upon moving south he
decided he would forgo living in a single family dwelling and instead opt for a condominium.
There were several condo complexes to choose from and most were owned predominately by
Canadians, U.S. citizens, and Europeans. Randy chose Bahia Mar Condominiums as his home
and in general was very satisfied with his choice.
Given Randy’s educational background (B.S. in accounting) and years spent as a hospital
controller it was no surprise that he was called upon by his neighbors to assist in the governance
of the homeowners association (HOA). With some reluctance he had allowed himself to be
elected treasurer of the Bahia Mar HOA’s Board of Directors last year. This means that he is
obligated to review the quarterly financial statements prepared by the management of the HOA.
Additionally he is responsible for presenting the proposed budget for the upcoming year to the
annual meeting of all 150 condo owners. It is the budget that is troubling him.
The HOA is responsible for building and grounds maintenance, security, maid service (if
desired), as well as general administration of the HOA which includes paying taxes, utilities,
billing owners, etc. Virtually all costs incurred are denominated in pesos. The current year’s
budgeted expenditures are 5,250,000 pesos. Approximately two-thirds of the budget is
comprised of salaries for various HOA employees.
The budgeting process is largely driven by the expenditures requested by management. Once
those have been justified and agreed upon by the Board of Directors of the HOA, management
converts the budget into U.S. dollars. The budgeted expenditures amount is then divided by
150, the number of condominiums, to determine the annual condominium fees. The resulting
annual fee is then divided by four as homeowner fees are paid quarterly on the first day of each
quarter. Since most condo owners’ primary residences are in the U.S. it was decided that condo
fees would be denominated in U.S. dollars rather than the local currency.
During the last few years management used an exchange rate of 10.5 pesos to the U.S. dollar to
convert the peso denominated budget into dollars. Actual exchange rates fluctuated between 9.9
and 13.9 pesos per U.S. dollar during that period. The manager of the HOA is insisting on
utilizing the same conversion factor as in the past years. His arguments range from
“consistency” to “no one can predict the future”. Randy is uncomfortable with this approach.
He takes his fiduciary responsibilities seriously and while on his watch as treasurer he wants the
budgeting process accomplished in a professional manner.
As the budgeting process moves forward Randy knows he must decide how he wants the
currency translation to be handled. He will also need to provide a coherent argument for his
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position and draft a memo for the HOA’s Board and manager. As Randy contemplates these
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Case ID 030303
exchange rate issues he notices a squall building rapidly a few miles to the west and moving his
way. Apparently it’s time to make some decisions both financial and navigational.
Appendix A
Depending on the extent of guidance the faculty member desires to provide to students, the
following information regarding the current situation (as of Sept. 20X0) may be provided:
The expected interest rate in the US for 20X1 is approximately 0.25%
The expected interest rate in Mexico for 20X1 is approximately 4.50%
The current spot rate is 13.03 pesos/US$.
A chart of the forward prices offered by a local bank is:
Date Futures Price: $/peso
Sept. 20X0 0.076925
Oct. 20X0 0.076400
Nov. 20X0 0.076100
Dec. 20X0 0.076275
Jan. 20X1 0.075775
Feb. 20X1 0.075475
Mar. 20X1 0.075125
Apr. 20X1 0.074975
May 20X1 0.074625
June 20X1 0.074400
July 20X1 0.074225
Aug. 20X1 0.074025
Sept. 20X1 0.073600
Dec. 20X1 0.072800
Questions
1. Assuming Mr. Bozarth would prefer to use external sources for an exchange rate, how would
you suggest a rate for converting next year’s budget from pesos to U.S. dollars be determined?
2. What alternate methods might Mr. Bozarth propose to the Board for dealing with foreign
currency fluctuations?
3. How might Mr. Bozarth go about formulating an estimate of the exchange rate for the
upcoming year rather than relying on external quotes?
4. What are the implications for the owners and the HOA manager of using the actual foreign
exchange rate as compared to the 10.5 pesos per U.S. dollar rate used in prior years’ budgeting
process? How might this influence the owners’ and manager’s preferences regarding the choice
of exchange rate for next year’s budget?
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Case ID 030303

The Case of The Drifting Exchange Rate

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International Research Journal of Applied Finance ISSN 2229 – 6891

March, 2012 Case Study Series

The Case of the Drifting Exchange Rate

Allen B. Atkins, Ph.D.

Roxanne Stell, Ph.D.

Larry Watkins, Ph.D., CPA

Allen B. Atkins, Northern Arizona University, [email protected]

Allen B. Atkins, Northern Arizona University, [email protected]

Allen B. Atkins, Northern Arizona University, [email protected]

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