You have been asked to evaluate possible sites for an South American production facility that will manufacture your firm's products and sell them to the South American market. What real exchange rate considerations should you entertain in your evaluation?

What will be an ideal response?

Answer: You must be aware of the strength or weakness of the real exchange rates in the various countries. Because your firm will be exporting from the country in which the plant is located, your profits will be hurt by a future real appreciation of the currency of that country relative to the currencies of countries to which you export. Your costs would rise with no corresponding benefit in sales. Thus, if the potential production country currency is currently severely undervalued on foreign exchange markets, this country may appear to be a low cost production center, but it is likely that this cost advantage will be eroded by a real appreciation in the future.