Blades, Inc. Case Forecasting Exchange Rates Recall that Blades, Inc., the U.S.-based manufacturer of roller blades, is currently both exporting to and importing from Thailand. Ben Holt, Blades'chief financial officer (CFO), and you, a financial analyst at Blades, are reasonably happy with Blades' current performance in Thailand. Entertainment Products, Inc., a Thai retailer for sporting goods, has committed itself to purchase a minimum number of Blades' Speedos annually. The agreement will terminate after three years. Blades also imports certain components needed to manufacture its products from Thailand. Both Blades' imports and exports are denominated in Thai baht. Because of these arrangements, Blades generates approximately 10 percent of its revenue and 4 percent of its cost of goods sold in Thailand. Currently, Blades' only business in Thailand consists of this export and import trade. Holt, however, is thinking about using Thailand to augment Blades' U.S. business in other ways in the future. For example, Holt is contemplating establishing a subsidiary in Thailand to increase the percentage of Blades sales to that country. Furthermore, by establishing a subsidiary in Thailand, Blades will gain access to Thailand's money and capital markets. For instance, Blades could instruct its Thai subsidiary to invest excess funds or to satisfy its short-term needs for funds in the Thai money market. Furthermore, part of the subsidiary's financing could be obtained by utilizing investment banks in Thailand. a Due to Blades' current arrangements and future plans, Holt is concerned about recent developments in Thailand and their potential impact on the company's future in that country. Economic conditions in Thailand have been unfavorable recently. Movements in the value of the baht have been highly volatile. Foreign investors in Thailand have lost confidence in the baht, causing massive capital outflows from Thailand. Consequently, the baht has been depreciating. When Thailand was experiencing a high economic growth rate, few analysts anticipated an economic downturn. In that environment, Holt never found it necessary to forecast economic conditions in Thailand, even though Blades was doing business there. Now, however, his attitude has changed. A continuation of the unfavorable economic conditions prevailing in Thailand could affect the demand for Blades' products in that country. In turn, Entertainment Products may not renew its commitment for another three years. Because Blades generates net cas inflows denominated in baht, a continued depreciation of the baht could adversely affect Blades, as these net inflows would be converted into fewer dollars. Thus, Blades is also considering hedging its baht-denominated inflows. Because of these concerns, Holt has decided to reassess the importance of forecasting the baht-dollar exchange rate. His primary objective is to forecast the baht-dollar exchange rate for the next quarter. A secondary objective is to determine which forecasting technique is the most accurate and should be used in future periods. To accomplish this, he has asked you, as the financial analyst at Blades, for help in forecasting the baht-dollar exchange rate for the next quarter. Holt is aware of the various forecasting techniques available. He has collected some economic data and conducted a preliminary analysis for you to use in your analysis. For example, he has conducted a time- series analysis for the exchange rates over numerous quarters. He then used this analysis to forecast the baht's value next quarter. Holt's technical forecast indicates a depreciation of the baht by 6 percent over the next quarter from the baht's current level of $0.023 to $0.02162. Holt has also conducted a fundamental forecast of the baht-dollar exchange rate using historical inflation and interest rate data. The fundamental forecast, however, depends on what happens to Thai interest rates during the next quarter; thus, it reflects a probability distribution. Based on the inflation and interest rates, there is a 30 percent chance that the baht will depreciate by 2 percent, a 15 percent chance that the baht will depreciate by 5 percent, and a 5 55 percent chance that the baht will depreciate by 10 percent. Holt has asked you to answer the following questions: 5. Assume that the technical forecast has been more accurate than the market-based forecast in recent weeks. What does this indicate about market efficiency for the baht-dollar exchange rate? Do you think it means that technical analysis will always be superior to other forecasting techniques in the future? Why or why not? 6. What is the expected value of the percentage change in the value of the baht during the next quarter based on the fundamental forecast? What is the forecasted value of the baht using the expected value as the forecast? If the value of the baht 90 days from now turns out to be $0.022, which forecasting technique is the most accurate? (Use the absolute forecast error as a percentage of the realized value to answer the last part of this question.) 7. Do you think the technique that you identified in question 6 will always be the most accurate? Why or why not? Blades, Inc. Case Forecasting Exchange Rates Recall that Blades, Inc., the U.S.-based manufacturer of roller blades, is currently both exporting to and importing from Thailand. Ben Holt, Blades'chief financial officer (CFO), and you, a financial analyst at Blades, are reasonably happy with Blades' current performance in Thailand. Entertainment Products, Inc., a Thai retailer for sporting goods, has committed itself to purchase a minimum number of Blades' Speedos annually. The agreement will terminate after three years. Blades also imports certain components needed to manufacture its products from Thailand. Both Blades' imports and exports are denominated in Thai baht. Because of these arrangements, Blades generates approximately 10 percent of its revenue and 4 percent of its cost of goods sold in Thailand. Currently, Blades' only business in Thailand consists of this export and import trade. Holt, however, is thinking about using Thailand to augment Blades' U.S. business in other ways in the future. For example, Holt is contemplating establishing a subsidiary in Thailand to increase the percentage of Blades sales to that country. Furthermore, by establishing a subsidiary in Thailand, Blades will gain access to Thailand's money and capital markets. For instance, Blades could instruct its Thai subsidiary to invest excess funds or to satisfy its short-term needs for funds in the Thai money market. Furthermore, part of the subsidiary's financing could be obtained by utilizing investment banks in Thailand. a Due to Blades' current arrangements and future plans, Holt is concerned about recent developments in Thailand and their potential impact on the company's future in that country. Economic conditions in Thailand have been unfavorable recently. Movements in the value of the baht have been highly volatile. Foreign investors in Thailand have lost confidence in the baht, causing massive capital outflows from Thailand. Consequently, the baht has been depreciating. When Thailand was experiencing a high economic growth rate, few analysts anticipated an economic downturn. In that environment, Holt never found it necessary to forecast economic conditions in Thailand, even though Blades was doing business there. Now, however, his attitude has changed. A continuation of the unfavorable economic conditions prevailing in Thailand could affect the demand for Blades' products in that country. In turn, Entertainment Products may not renew its commitment for another three years. Because Blades generates net cas inflows denominated in baht, a continued depreciation of the baht could adversely affect Blades, as these net inflows would be converted into fewer dollars. Thus, Blades is also considering hedging its baht-denominated inflows. Because of these concerns, Holt has decided to reassess the importance of forecasting the baht-dollar exchange rate. His primary objective is to forecast the baht-dollar exchange rate for the next quarter. A secondary objective is to determine which forecasting technique is the most accurate and should be used in future periods. To accomplish this, he has asked you, as the financial analyst at Blades, for help in forecasting the baht-dollar exchange rate for the next quarter. Holt is aware of the various forecasting techniques available. He has collected some economic data and conducted a preliminary analysis for you to use in your analysis. For example, he has conducted a time- series analysis for the exchange rates over numerous quarters. He then used this analysis to forecast the baht's value next quarter. Holt's technical forecast indicates a depreciation of the baht by 6 percent over the next quarter from the baht's current level of $0.023 to $0.02162. Holt has also conducted a fundamental forecast of the baht-dollar exchange rate using historical inflation and interest rate data. The fundamental forecast, however, depends on what happens to Thai interest rates during the next quarter; thus, it reflects a probability distribution. Based on the inflation and interest rates, there is a 30 percent chance that the baht will depreciate by 2 percent, a 15 percent chance that the baht will depreciate by 5 percent, and a 5 55 percent chance that the baht will depreciate by 10 percent. Holt has asked you to answer the following questions: 5. Assume that the technical forecast has been more accurate than the market-based forecast in recent weeks. What does this indicate about market efficiency for the baht-dollar exchange rate? Do you think it means that technical analysis will always be superior to other forecasting techniques in the future? Why or why not? 6. What is the expected value of the percentage change in the value of the baht during the next quarter based on the fundamental forecast? What is the forecasted value of the baht using the expected value as the forecast? If the value of the baht 90 days from now turns out to be $0.022, which forecasting technique is the most accurate? (Use the absolute forecast error as a percentage of the realized value to answer the last part of this question.) 7. Do you think the technique that you identified in question 6 will always be the most accurate? Why or why not