Question

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have lost confidence in Thailand and have withdrawn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 illustrations 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:

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.

2. What are the basic factors that determine the value

of a currency? In equilibrium, what is the relationship

between these factors?

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