QUESTION 1 HAS TWO PARTS (A， B) FOR A TOTAL OF 6 MINUTES.

 

　　Vacations Unlimited Inc. (VU)， a U.S.-based tourism company， has a majority stake in Yucatan Resorts， a Mexican firm that owns and operates luxury resorts along Mexico‘s Caribbean coast.Because most of its client base consists of U.S. tourists， Yucatan Resorts’ revenues are denominated in U.S. dollars. Yucatan Resorts converts all U.S. dollar receipts into Mexican pesos through the foreign exchange market. Yucatan Resorts‘ operating costs are all denominated in pesos and assumed to increase in line with the Mexican inflation rate， and the firm’s assets and liabilities are all denominated in pesos. Yucatan Resorts‘ shares trade on the Mexican stock exchange and are also denominated in pesos.George Davies， VU’s Chief Financial Officer， is considering increasing VU‘s investment in Yucatan Resorts. He is aware， however， that the Mexican inflation rate has been higher than the inflation rate in the U.S. and that the Mexican peso has been depreciating against the U.S. dollar.Davies is concerned that a continuation of these trends might reduce Yucatan Resorts’ profitability. He asks Iris Hamson， a financial analyst at VU， to investigate the relationship between Yucatan Resorts‘ share price， nominal exchange rates between the peso and the dollar，and inflation rates in Mexico and the U.S. Hamson states：“Based on Yucatan Resorts’ sources of revenues and costs， and given that purchasing power parity is unlikely to hold， I conclude that Yucatan Resorts‘ local currency exposure will be characterized by a negative correlation between Yucatan’s share price (measured in pesos) and the value of the peso.”

 

　　A. Define local currency exposure.

 

　　(3 minutes)

 

　　B. State whether Hamson‘s conclusion about Yucatan Resorts’ local currency exposure is

 

　　correct or incorrect. Justify your response with one reason.

 

　　(3 minutes)