Recall that your Mexican business invoices in Mexican pesos.
a. You are already aware that a decline in the value of the peso could reduce your dollar cash flows. Yet, according to purchasing power parity, a weak peso should only occur in response to a high level of Mexican inflation, and such high inflation should increase your profits. If this theory holds precisely, your cash flows would not really be exposed. Should you be concerned about your exposure, or not? Explain.
b. If you shift your invoicing policy to be only in dollars, how will your transaction exposure be affected?
c. Why might the demand for your business change if you shift your invoice policy? What are the implications for economic exposure?
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