Blades, Inc. Case Forecasting Exchange Rates (two questions at the end of the case study)

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, Inc., 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 as well 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

have 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. 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,

and 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. Consequently, 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. Consequently, Entertainment

Products may not renew its commitment for another three years. Because Blades

generates net cash 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

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.

The technical forecast indicates a depreciation of the baht by 6 percent over

the next quarter from the baht's current level of $.023 to $.02162. He 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 and

therefore 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

55 percent chance that the baht will depreciate by 10 percent.

Questions:

1 - Use technical forecasting including the performance evaluation

bias and its graphic evaluation to forecast the future of the baht.

2 -Which forecasting technique (fundamental, technical or

market-based) would be easiest to use in forecasting the future value of the

baht? Why?