Assessment of Government Influence on Exchange Rates

Objectives and Learning Outcomes: The main objective of the assignment is to develop the knowledge of global and cultural systems and issues. Upon successful completion of this course, you will be able to identify and describe major global issues in financial markets and the effects of country-level risk.

Instruction: Suppose that, as a financial analyst, you are tasked with evaluating Blades, a U.S. manufacturer of roller blades. In the assignment, you provide the chief financial officer (CFO) of Blades a better understanding of the process of government intervention and its impact on Blades international business. The company generates most of its revenue and incurs most of its expenses in the United States. However, it has recently begun exporting roller blades to Thailand. You will provide a report that includes your assessment of the Thai government intervention and its impact on the exchange rate of baht. You are asked to analyze the following issues and provide solutions to Blades.

Discuss whether the intervention effort by the Thai government constitute direct or indirect intervention.

Discuss whether the intervention by the Thai government constitute sterilized or nonsterilized intervention and the difference between the types of intervention.

Which type of government intervention (sterilized vs. nonsterilized) do you think would be more effective in increasing the value of the baht? Once you choose one of the types, justify your answer.

If the Thai baht is virtually fixed with respect to the dollar, what would happen to the U.S. levels of inflation?

What are some of the potential disadvantages for Thai levels of inflation associated with the floating exchange rate system that is now used in Thailand?

What do you think will happen to the Thai bahts value when the swap arrangement is reversed later?

Do you have any other suggestions to Mr. Holt with regard to Blades business in this circumstance?

Before you analyze, review Chapter 6 and course slides carefully. Limit your report in two pages (single space).

Blades, Inc.: Blades has an agreement with Entertainment Products, Inc., a Thai importer, for a 3-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 baht 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 baht per pair of Speedos. No contractual agreement exists between Blades, Inc., and the Thai exporter. Consequently, the cost of the rubber and plastic components imported from Thailand is subject not only to exchange rate considerations but to economic conditions (such as inflation) in Thailand as well.

Shortly after Blades began exporting to and importing from Thailand, Asia experienced weak economic conditions. Consequently, foreign investors in Thailand feared the bahts potential weakness and withdrew their investments, resulting in an excess supply of Thai baht for sale. Because of the resulting downward pressure on the bahts value, the Thai government attempted to stabilize the bahts exchange rate. To maintain the bahts value, the Thai government intervened in the foreign exchange market. 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 exchange market. However, this agreement required Thailand to reverse this transaction by exchanging dollars for baht at a future date. Unfortunately, the Thai governments intervention was unsuccessful, as it was overwhelmed by market forces. Consequently, the Thai government ceased its intervention efforts, and the value of the Thai baht declined substantially against the dollar over a 3-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 would continue to decline indefinitely. Since Blades generates net inflow in Thai baht, this would seriously affect the companys profit margin. Furthermore, one of the reasons Blades had expanded into Thailand was to appease the companys shareholders. At last years annual shareholder meeting, they had demanded that senior management take action to improve the firms low profit margins. Expanding into Thailand had been Holts suggestion, and he is now afraid that his career might be at stake. For these reasons, Holt feels that the Asian crisis and its impact on Blades demand his serious attention. One of the factors Holt thinks he should consider is the issue of government intervention and how it could affect Blades in particular. Specifically, he wonders whether the decision to enter into a fixed agreement with Entertainment Products was a good idea under the circumstances. Another issue is how the future completion of the swap agreement initiated by the Thai government will affect Blades. To address these issues and to gain a little more understanding of the process of government intervention, Holt has prepared the following list of questions for you, Blades financial