Case Study Assessment of Government's intervention on exchange rate

Blades, the US manufacture of roller blades generates most of its revenues and most of its expenses in the United States. However the company has recently began exporting roller blades to Thailand. The company has an agreement with Entertainment products Inc. a THAILAND company for 3 years period. According to the terms of agreement, Entertainment Products Inc. will purchases 180,000 pairs of "Speedos" the company's primary product, annually at a fixed price of 4594 Thai baht per pair. Due to quality and cost considerations, the company is also importing certain rubber and plastic components from a Thailand exporter; the cost of these components is approximately 2871 Thai baht per pair of Speedos. No contractual agreement exists between the company and the Thailand exporter. Consequently the cost of rubber and plastic components imported from Malaysia is subject not only to exchange rate considerations but to economic conditions (such as inflation) in Thailand as well. Shortly after the company began exporting to and importing from Thailand, Asia experienced weak economic conditions. Consequently, foreign investors feared the baht's potential weakness and withdrew their investments, resulting in an excess supply of Thai baht for sale. Because of the resulting downward pressure on the baht's value, the Thai government attempted to stabilize the baht's exchange rate. To stabilize the baht's value, the Thai government intervened in the foreign exchange market. Specifically, it swapped its baht reserves for 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 government's intervention was unsuccessful, as it was overwhelmed by market forces. Consequently, the Thai government ceased its intervention efforts, and the value of Thai baht declined by more than 20% against the dollar over a five week period. When the Thai government stopped intervening in the foreign exchange market, the company's CFO, was concerned that the value of the Thai baht would continue to decline indefinitely. Since the company generates net inflows in Thai baht, this would seriously affect the company's profit margin. Furthermore, one of the reasons the company had expanded into Thailand was to appease the company's shareholders. At last year's annual shareholders meeting, they had demanded that senior management take action to improve the firm's low profit margins. Expanding into Thailand has been Holt's suggestion, and he is now afraid that his career might be at stake for these reasons; Holt feels that the Asian crises and its impact on the company need his serious attention. One of the factors Holt thinks he should consider is the issue of government intervention and how it could affect the company in particular. Specifically, he wonders whether the decision to enter into a fixed agreement with the 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 the company. To address these issues and to gain a little more understanding of the process of government intervention, Holt has prepared the list of questions for you, the financial analyst, since he knows that you understand financial management.

Questions:

If the Thai baht is virtually fixed with respect to the dollar, how could this affect US levels of inflation?

Do think these effects on the US economy will be more pronounced for companies such as Blades that operate under trade arrangements involving commitments or for firms that do not?

How are companies such as blades affected by a fixed exchange rate?