The Environment. The case references USD ex- change rates from the 1980s and 1990s in terms of Deutsch(e) Mark (DEM), Germany’s old money before the advent of European Monetary Union and the common currency Euro, which now is the official currency of 19 of the 27 member states of the European Union. With the introduction of the Euro in 1999, the official conversion rate for Deutsche Mark was set to 1.95583/EUR.
The euro was introduced to world financial markets as an accounting currency on 1 January 1999, replacing the former European Currency Unit (ECU) at a ratio of 1:1 (US$1.1743). Physical euro coins and banknotes entered into circulation on 1 January 2002, making it the day-to-day operating currency of its original members, and by March 2002 it had completely replaced the former currencies.
(a) What kind of quote is $0.34/DEM and $0.64/DEM in 1985 and 1992, respectively? What is the price of $1 in terms of DEM?
(b) When the Euro was introduced, the official conversion rate for the DEM was fixed at DEM 1.95583/EUR. What would have been the USD/EUR exchange rate on average in 1985 and 1992, respectively?
(c) In 1992, a BMW which sold for DEM 50,000 marks in Germany sold in the United States for $32,000. Compute the implied PPP exchange rate in terms of both DEM and EUR. Is the USD over or undervalued? What can BMW do in light of the prevailing exchange rates in 1992 to make their cars more appealing to US customers?
(d) Auto workers in the US made approximately $23.50 hourly on average in terms of wages ($15)andbenefits($8.50)intheearly1990s.1(1 See https://www.bls.gov/opub/mlr/2019/article/earnings-of-production-workers-in-manufacturing-1990-2018.htm and various other sources. ) How much did German auto workers make in USD and DEM during the same period? What is the USD/DEM break-even PPP exchange rate in terms of wage and benefit costs? What are the competitive implications for BMW?
(e) Given your preceding analysis, advise BMW on their globalization strategy. What other problems can the company address through your recommended course of action?
(f) Bonus problem. BMW estimates that in the 1990s the US will retain a cost advantage of about 30% over the German car industry in terms of hourly compensation (wages and benefits). Assuming that hourly compensation in the US car industry remains steady throughout the decade, what does this assumption imply for the German hourly compensation by the year 2000? What are the corresponding break-even FX rates in terms of the Euro?
Sample Solution
