Reference no: EM132952515

Assessment of Future Exchange Rate Movements

As the chief financial officer of Blades, Inc., Ben Holt is pleased that his current system of exporting "Speedos" to Thailand seems to be working well. Blades' primary customer in Thailand, a retailer called Entertainment Products, has committed itself to purchasing a fixed number of Speedos annually for the next 3 years at a fixed price denominated in baht, Thailand's currency. Furthermore, Blades is using a Thai supplier for some of the components needed to manufacture Speedos. Nevertheless, Holt is concerned about recent developments in Asia. Foreign investors from various countries had invested heavily in Thailand to take advantage of the high interest rates there. As a result of the weak economy in Thailand, however, many foreign investors have lost confidence in Thailand and have withdrawn their funds.

Holt has two major concerns regarding these developments. First, he is wondering how these changes in Thailand's economy could affect the value of the Thai baht and, consequently, Blades. More specifically, he is wondering whether the effects on the Thai baht may affect Blades even though its primary Thai customer is committed to Blades over the next 3 years.

Second, Holt believes that Blades may be able to speculate on the anticipated movement of the baht, but he is uncertain about the procedure needed to accomplish this. To facilitate Holt's understanding of exchange rate speculation, he has asked you, Blades' financial analyst, to provide him with detailed illustra- tions of two scenarios. In the first, the baht would move from a current level of $.022 to $.020 within the next 30 days. Under the second scenario, the baht would move from its current level to $.025 within the next 30 days.

Based on Holt's needs, he has provided you with the following list of questions to be answered:

Problem 1. How are percentage changes in a currency's value measured? Illustrate your answer numerically by assuming a change in the Thai baht's value from a value of $.022 to $.026.

Problem 2. What are the basic factors that determine the value of a currency? In equilibrium, what is the relationship between these factors?

Problem 3. How might the relatively high levels of inflation and interest rates in Thailand affect the baht's value. (Assume a constant level of U.S. inflation and interest rates.)

Problem 4. How do you think the loss of confidence in the Thai baht, evidenced by the withdrawal of funds from Thailand, will affect the baht's value? Would Blades be affected by the change in value, given the primary Thai customer's commitment?

Problem 5. Assume that Thailand's central bank wishes to prevent a withdrawal of funds from its country in order to prevent further changes in the currency's value. How could it accomplish this objective using interest rates?

Problem 6. Construct a spreadsheet illustrating the steps Blades' treasurer would need to follow in order to speculate on expected movements in the baht's value over the next 30 days. Also show the speculative profit (in dollars) resulting from each scenario. Use both of Holt's examples to illustrate possible speculation. Assume that Blades can borrow either $10 million or the baht equivalent of this amount. Furthermore, assume that the following short-term interest rates (annualized) are available to Blades:

                              CURRENCY LENDING RATE                   BORROWING RATE

Dollars                         8.10%                                       8.20%

Thai baht                   14.80%                                       15.40%