As the chief financial officer of Blades, Inc., Ben Holtis 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 pur- chasing a fixed number of Speedos annually for the next 3 years at a fixed price denominated in baht, Thailands 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 ad- vantage of the high interest rates there. As a result of the weak economy in Thailand, however, many foreign in- vestors have lost confidence in Thailand and have with- drawn their funds.

Ben Holt has two major concerns regarding these developments. First, he is wondering how these changes in Thailands 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 cus- tomer 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 ac- complish this. To facilitate Holts understanding of exchange rate speculation, he has asked you, Blades financial analyst, to provide him with detailed illus- trations 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 Holts needs, he has provided you with the following list of questions to be answered:

1. What are the basic factors that determine the value of a currency? In equilibrium, what is the relation- ship between these factors?

2. How might the relatively high levels of inflation and interest rates in Thailand affect the bahts value? (Assume a constant level of U.S. inflation and interest rates.)