Blades Case

Chapter $8$

Relationship among inflation, interest rates, and exchange rates

Assume the following information:

$$ The current spot exchange rate today $($January $1)$ of the Thai baht is $$0\mathrm{.}024$

$$ Blades sells $180,000$ pairs of roller blades to Entertainment Products at the fixed price of

THB$4,594$ per pair to be paid after a year

$$ Rubber and plastic are imported from Thailand for $80,000$ pairs of roller blades. The payment is

completed at the end of the year.

$$ The current price of rubber and plastic per pair of roller blades is THB $2,300.$

$$ Prices adjusted by inflation at the end of the year.

$$ Inflation in Thailand $21\%,$ inflation in the US $5\%$

$$ The nominal interest rate in Thailand is $14\%$ and the nominal interest rate in the US is $4\%$

Questions:

$1.$ What is the relationship between the expected future spot rate USD$/$THB and the relative inflation

levels of the two countries? Assuming the PPP holds, how will this relationship affect Blades$$ Thai

revenues and costs assuming there is a contract with constant sales prices for roller blades? $($no

calculations required$)$

$2.$ Assuming the PPP holds, a$)$ what is the expected exchange rate of THB$?$ b$)$ What is the net effect of

signing a contract with fixed prices vs signing a contract without fixed prices to export rollerblades?

$3.$ Assuming PPP and IRP hold, would Blades prefer to hedge its revenues by a futures contract or keep

them unhedged? Calculate the total benefit of the selection.

$4.$ How do you reconcile the high level of interest rates in Thailand with the expected change of the spot

rate according to IFE? $($no calculation required$)$

$5.$ Based on your answer to question $4,$ calculate the expected exchange rate USD$/$TBH of equilibrium

according to IFE theory. Ben Holt firmly believes that the IFE will hold, but he wants to analyze what is

better for Blades: accept payments of sales and costs today $($at the beginning of the year$)$ or at the end

of the period.