Assessment of Exchange Rate Exposure

Blades plc is currently exporting rollerblades to Thailand and importing certain components needed to manufacture roller blades from that country. Under a fixed contractual agreement, Blades primary customer in Thailand has committed itself to purchase 180,000 pairs of rollerblades annually at a fixed price of 4,594 Thai baht (THB) per pair. Blades is importing rubber and plastic components from various suppliers in Thailand at a cost of approximately THB 2,871 per pair, although the exact price (in baht) depends on current market prices. Blades imports materials sufficient to manufacture 72,000 pairs of roller blades from Thailand each year. The decision to import materials from Thailand was reached because rubber and plastic components needed to manufacture Blades products are inexpensive, yet high quality, in Thailand. Blades has also conducted business with a Japanese supplier in the past. Although Blades analysis indicates that the Japanese components are of a lower quality than the Thai components, Blades has occasionally imported components from Japan when the prices were low enough. Currently, Ben Holt, Blades Finance Director, is considering importing components from Japan more frequently. Specifically, he would like to reduce Blades baht exposure by taking advantage of the recently high correlation between the baht and the yen. If Blades decides to import components from Japan, it would probably import materials sufficient to manufacture 1,700 pairs of roller blades annually at a price of 7,440 per pair.

Holt is also contemplating further expansion into foreign countries. Although he would eventually like to establish a subsidiary or acquire an existing business overseas, his immediate focus is on increasing Blades foreign sales. Holts primary reason for this plan is that the profit margin from Blades imports and exports

exceeds 25 per cent, while the profit margin from Blades domestic production is below 15 per cent. Consequently, he believes that further foreign expansion will be beneficial to the companys future.

Though Blades current exporting and importing practices have been profitable, Ben Holt is contemplating extending Blades trade relationships to countries in different regions of the world. One reason for this decision is that various Thai rollerblade manufacturers have recently established subsidiaries in the UK. Furthermore, various Thai rollerblade manufacturers have recently targeted the UK market by advertising their products over the internet. As a result of this increased competition from Thailand, Blades is uncertain whether its primary customer in Thailand will renew the current commitment to purchase a fixed number of rollerblades annually. The current agreement will terminate in two years. Another reason for engaging in transactions with other, non-Asian, countries is that the Thai baht has depreciated substantially recently, which has somewhat reduced Blades profit margins. The sale of rollerblades to other countries with more stable currencies may increase Blades profit margins.

While Blades will continue exporting to Thailand under the current agreement for the next two years, it may also export rollerblades to Jogs Inc, a US retailer. Preliminary negotiations indicate that Jogs would be willing to commit itself to purchase 200,000 pairs of Speedos, Blades primary product, for a fixed price of $80 per pair.

Holt believes that Blades can supplement its profit margins by expanding. He is vaguely familiar with the different types of exchange rate exposure but has asked you, a financial analyst at Blades plc, to help him assess how the contemplated changes would affect Blades financial position. Among other concerns, Holt is aware that recent economic problems in Thailand have had an effect on Thailand and other Asian countries. Whereas the correlation between Asian currencies such

as the Japanese yen and the Thai baht is generally not very high and very unstable, these recent problems have increased the correlation among most Asian currencies. Conversely, the correlation between the British pound and the Asian currencies is quite low. To aid you in your analysis, Holt has provided you with the following data:

Holt has asked you to answer the following questions:

Currency	Expected exchange rate	Range of possible exchange rates
US Dollar	0.67	0.68 to 0.65
Thai baht	0.016	0.013 to 0.019

1. Explain the currency exposure Blades is subject to using appropriate terminology.

2. Calculate the net exposure from cash flows in Thai Bath assuming the maximum depreciation of the Bath as stated in the table.

3. Explain how Blades can use different techniques to hedge their currency exposure.

4. If Blades does not enter into the agreement with the US firm and continues to export to Thailand and import from Thailand and Japan, do you think the increased correlations between the Japanese yen and the Thai baht will increase or reduce Blades transaction exposure?

5. Assuming Blades enters into the agreement with Jogs Inc, how will its overall transaction exposure be affected?

6. Given that Thai rollerblade manufacturers located in Thailand have begun targeting the UK rollerblade market, how do you think Blades UK sales were affected by the depreciation of the Thai baht? How do you think its exports to Thailand and its imports from Thailand and Japan were affected by the depreciation?