Answers to questions 1-5. Thank you!
Assessment of Government influence on Exchange Rates Recall that Blades, Inc., the U.S. manufacturer of roller blades, generates most of its revenue and incurs most of its expenses in the United States. However, the company has recently begun exporting roller blades to Thailand. The company has an agreement with Entertainment Products, Inc. a Thai importer, for a three-year period. According to the terms of the agreement, Entertainment Products will purchase 180,000 pairs of "Speedos." Blades' primary product, annually at a fixed price of 4,594 Thai bahe per pair. Due to quality and cost considerations, Blades is also importing certain rubber and plastic components from a Thai exporter. The cost of these components is approximately 2.871 Thai haht per pair of Speedos. No contractual agreement exists between Blades and the Thai exporter, so the cost of the rubber and plastic components imported from Thailand is subject to both exchange rate considerations and economic conditions (such as inflation) in Thailand. Shortly after Blades began exporting to and importing from Thailand, Asia experienced weak economic conditions. Because of their fears about the bahri potential weakness, foreign inveitors moved their investments out of Thailand, resulting in an excess supply of Thai baht for sale. To counteract the resulting downward pressure on the baht's value, the Thai government sought to stabilitae the baht's exchange rate. It intervened in the forcign exchange market to maintain the bahr's value; specifically, it swapped its baht reserves for dollar reserves at other central banks and then used its dollar reserves to purchase the baht in the foreign exchanger market. However, this agreement required Thailand to reverse this transaction by exchanging dollars for tuht at a future date. Unfortunately, the Thai gowernment's intervention was unsuccessful, as it was overwhelmed by market forces. Consequently, the Thai government ceased its intervention efforts, and the value of the That baht declined substantially againat the dollar over a three-month period. When the Thai government stopped intervening in the foreign exchange market, Ben Holt, Blades' CFO. was concerned that the value of the Thai baht wou continue to decline indefinitely. Because Blades gene ates net inflow in Thai baht, this would seriously affe the company's profit margin. Furthermore, one rease why Blades had expanded into Thailand was to appea the company's shareholders. At last year's annual shar holder meeting, they had demanded that senior ma agement take action to improve the firm's low pro margins. Expanding the company's operations in Thuiland had been Holt's suggestion, and he is ne afraid that his career might be at stake. For these re sons, Holt believes that the Asian crists and its impa on Blades demand his serious attention. One factor that Holt is considering is the issue of go ernment intervention and how it could affect Blades purticular. Specifically, be wonders whether the dec wion to enter into a fixed agreement with Entertainme Products was a good idea under the circumstance Another issue is how the future completion of the sw: agreement initiated by the Thai government will affe Blades. To address these issues and to gain more insig into the process of government intervention, Holt h propared the following list of questions for you, Bladk financial analyst, as he knows that you understai international financial management. 1. Did the intervention effort by the Thai government constitute direct or indirect intervention? Explain. 2. Did the intervention by the Thai government col stitute sterilized ot nonsterilized intervention? What is the difference between the types of interventions? Which type do you think would be more effective in increasing the value of the baht? Why? (Hint: Think about the effect of nonsterilized intervention on U.S. interest rates.) 3. If the Thai baht is virtually fixed with respect to the dollar, how could this affect U.S. levels of infla. tion? Do you think these effects on the U.S. economy will be more pronounced for companies such as Blad 216. Part 2: Exchange Rate Behavior that operate under trade arrangernents involving commaitments or for firms that do not? How are coernpanies such as Hlades affected by a fixed exchange rate? 4. What afe some of the potential disadvantages in terms of the level of inflation associated with the float. ing exchange rate system that is now used in Thailand? Do you think Blades contributes to these disadvantages to a great extent? How are companies sach as Blades affected by a fredy floating exchange rate? 5. What do yoe think will happen to the Thai baht's value when the swap arrangement is completed? How will this affect Blades
