Reference no: EM131713907

Assignment: BLADES, INC. CASE

Assessment of Government Influence on Exchange Rates

Recall that Blades, the U.S. manufacturer of rollerblades, generates most of its revenue and incurs mostof its expenses in the United States. However, the companyhas recently begun exporting roller blades toThailand. The company has an agreement with EntertainmentProducts, Inc., a Thai importer, for a 3-yearperiod. According to the terms of the agreement, Entertainment Products will purchase 180,000 pairs of"Speedos," Blades' primary product, annually at a fixedprice of 4,594 Thai baht per pair. Due to quality andcost considerations, Blades is also importing certainrubber and plastic components from a Thai exporter.The cost of these components is approximately 2,871Thai baht per pair of Speedos. No contractual agreementexists between Blades, Inc., and the Thai exporter.Consequently, the cost of the rubber and plastic componentsimported from Thailand is subject not only toexchange rate considerations but to economic conditions(such as inflation) in Thailand as well.

Shortly after Blades began exporting to and importingfrom Thailand, Asia experienced weak economic conditions.

Consequently, foreign investors in Thailand fearedthe baht's potential weakness and withdrew their investments,resulting in an excess supply of Thai baht for sale.

Because of the resulting downward pressure on the baht'svalue, the Thai government attempted to stabilize thebaht's exchange rate. To maintain the baht's value, the Thai government intervened in the foreign exchangemarket. Specifically, it swapped its baht reserves for dollarreserves at other central banks and then used its dollarreserves to purchase the baht in the foreign exchangemarket. However, this agreement required Thailand toreverse this transaction by exchanging dollars for bahtat a future date. Unfortunately, the Thai government'sintervention was unsuccessful, as it was overwhelmedby market forces. Consequently, the Thai governmentceased its intervention efforts, and the value of theThai baht declined substantially against the dollar over a3-month period.

When the Thai government stopped intervening inthe foreign exchange market, Ben Holt, Blades' CFO,was concerned that the value of the Thai baht wouldcontinue to decline indefinitely. Since Blades generatesnet inflow in Thai baht, this would seriously affect thecompany's profit margin. Furthermore, one of the reasonsBlades had expanded into Thailand was to appeasethe company's shareholders. At last year's annual shareholdermeeting, they had demanded that senior managementtake action to improve the firm's low profitmargins. Expanding into Thailand had been Holt's suggestion,and he is now afraid that his career might be atstake. For these reasons, Holt feels that the Asian crisisand its impact on Blades demand his serious attention.

One of the factors Holt thinks he should consider is theissue of government intervention and how it could affectBlades in particular. Specifically, he wonders whether thedecision to enter into a fixed agreement with EntertainmentProducts was a good idea under the circumstances.

Another issue is how the future completion of the swapagreement initiated by the Thai government will affectBlades. To address these issues and to gain a little moreunderstanding of the process of government intervention,Holt has prepared the following list of questionsfor you, Blades' financial analyst, since he knows thatyou understand international financial management.

1. Did the intervention effort by the Thai governmentconstitute direct or indirect intervention? Explain.

2. Did the intervention by the Thai government constitutesterilized or nonsterilized intervention? What is thedifference between the types of intervention? Which typedo you think would be more effective in increasing thevalue of the baht? Why? (Hint: Think about the effect ofnonsterilized intervention on U.S. interest rates.)

3. If the Thai baht is virtually fixed with respect to thedollar, how could this affect U.S. levels of inflation? Doyou think these effects on the U. S. economy will bemore pronounced for companies such as Blades thatoperate under trade arrangements involvingcommitments or for firms that do not? How are companiessuch as Blades affected by a fixed exchange rate?

4. What are some of the potential disadvantages forThai levels of inflation associated with the floatingexchange rate system that is now used in Thailand? Doyou think Blades contributes to these disadvantages toa great extent? How are companies such as Bladesaffected by a freely floating exchange rate?

5. What do you think will happen to the Thai baht'svalue when the swap arrangement is completed? Howwill this affect Blades?