As the chief financial officer of Blades plc, 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 three 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 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As a result of the weak economy in Thailand, however, many foreign investors have lost confidence in Thailand and have withdrawn their funds.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 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 customer is committed to Blades over the next three 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 Holts understanding of exchange rate speculation, he has asked you, Blades financial analyst, to provide him with detailed illustrations of two scenarios. In the first scenario, the baht would move from a current level of 0,0147 to 0,0133 within the next 30 days.

In the second scenario, the baht would move from its current level to 0,0167 within the next 30 days. Based on Holts needs, and assuming a 360-day year, answer the following questions:

a) What are the basic factors that determine the value of a currency? In equilibrium, what is the relationship between these factors? (5)

b) How might the relatively high levels of inflation and interest rates in Thailand have affected the value of the baht? (Assume a constant level of UK inflation and interest rates.) (5)

c) How do you think the loss of confidence in the Thai baht, evidenced by the withdrawal of funds from Thailand, affected the value of the baht? Would Blades be affected by the change in value, given the commitment of its primary Thai customer; and if so, how? (4)

d) Assume that Thailands central bank wishes to prevent a withdrawal of funds from its country in order to prevent further changes in the value of the currency. How could it accomplish this objective using interest rates? (4)

e) Set out the steps Blades financial manager would need to follow in order to speculate on expected movements in the value of the baht over the next 30 days. Also show the speculative profit (in pounds) resulting from each scenario. Use both of Ben Holts 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 (annualised) are available to Blades:

Currency British pound Thai baht

Lending rate 8,10% 14,80%

Borrowing rate 8,20% 15,40%