My questions

Define currency risk

Discuss factors that cause and contribute to changes in currency exchange rates and a firms exposure to exchange rate fluctuations.

Issue #1:

Issue #2:

Discuss how currency rate fluctuations and currency risks apply to a firms:

*Discuss the effect on Balance Sheet

*Discuss the effect on Income Statement

*Discuss the effect on Cash Flow Statement

UVA-GEM-0108 Rev. Jul. 29, 2013 CURRENCY CRISES IN THE UNITED KINGDOM AND HONG KONG As Arturo Rodrigo was riding the early morning Metro North train from Manhattan to Greenwich, Connecticut, in late December 2010, his thoughts turned to past currency crises. At this point, most emerging markets were struggling to contain the appreciation of their currencies, so perhaps currency crises were not likely in the foreseeable future. But Rodrigo knew conditions could change quickly, so during this quiet holiday season, he would take advantage of the luxury of thinking through issues in relative calm. In another week or so, his days would be too full for proper thinking. Rodrigo set about to refresh his knowledge of currency crises in general, and two specific crises: United Kingdom in 1992 and Hong Kong in 1998. These were two very different types of crises, and understanding them could serve him well when future crises occurred. Fixed Exchange Rates: The Pros and Cons Rodrigo's first task was to understand why countries chose to have fixed or floating exchange rates. Whether, and to what extent, to manage the exchange rate was a fundamental policy decision every government had to make. What were the costs and benefits of fixed and floating exchange rates? The benefits of a fixed exchange rate could be enumerated in the following way: Eliminate transaction costs associated with foreign currency. With fixed exchange rates, transactions costs for international trade are greatly reduced, thereby enabling increased international trade. Some costs remainthink of it as purchasing, while in Charlottesville, goods produced in Minneapolis. Transportation costs remain, and different states can set up various impediments to trade, but currency costs are eliminated. Reduce exchange rate uncertainty, lower hedging costs. With fixed exchange rates, exchange rate uncertainty is greatly reduced. Consider the producer who imports inputs This case was prepared by Frank Warnock, Paul M. Hammaker Professor of Business Administration. It was written as a basis for class discussion rather than to illustrate effective or ineffective handling of an administrative situation. Copyright 2011 by the University of Virginia Darden School Foundation, Charlottesville, VA. All rights reserved. To order copies, send an e-mail to sales@dardenbusinesspublishing.com. No part of this publication may be reproduced, stored in a retrieval system, used in a spreadsheet, or transmitted in any form or by any means electronic, mechanical, photocopying, recording, or otherwisewithout the permission of the Darden School Foundation. This document is authorized for use by hao xie, from 1/11/2016 to 3/3/2016, in the course: MBA 7294: Advanced Financial Analysis - John Bish (Spring 2016), Wilmington University. Any unauthorized use or reproduction of this document is strictly prohibited. -2- UVA-GEM-0108 and then sells final goods into the domestic market. With a flexible exchange rate, input costs fluctuate, greatly affecting the bottom line (and, hence, the ability to operate at all). Hedging the exchange rate exposure is one option, but hedging does not come for free. With truly fixed exchange rates, currency fluctuations are not something the producer is concerned with. Credibility of the central bank. Because fixing the exchange rate requires ceding your monetary policy to the country you have fixed your rates to, you immediately gain the credibility of that central bank. This can help bring about macroeconomic stability and greatly reduced interest rates, and, hence, greatly reduce borrowing costs. The costs of a fixed exchange rate, as it turns out, could be enumerated with the same list, but with a different twist: Eliminate transaction costs associated with foreign currency. With fixed exchange rates, transactions costs for international trade are greatly reduced, thereby enabling increased international trade. Your citizens could use this opportunity to overspend on imported goods. If your domestic industries are efficient and can compete, this should be fine. If they are not, the productive capacity of your economy will emigrate. Reduce exchange rate uncertainty, lower hedging costs. With fixed exchange rates, exchange rate uncertainty is greatly reduced. But it is not zero. There is always some probability that the fixed exchange rate will be given up in favor of a flexible exchange rate. If you have unhedged foreign-currency liabilities when a peg is broken, you will immediately become bankrupt. Credibility of the central bank. Because fixing the exchange rate requires ceding your monetary policy to the country you have fixed your rates to, you immediately gain the credibility of that central bank. Why? Because you have also fixed your monetary policy to its monetary policy. This can greatly reduce interest rates and hence borrowing costs, but is it appropriate? Are your business cycles in sync with the other country's? Consider the case in which the core country is facing recession while your economy is booming. The core loosens monetary policy to stimulate growth, and you must loosen policy too, supercharging your boom. The opposite casethe core is booming and needs to tighten monetary policy, but your country is suffering from weak growthhas you exacerbating a recession just to maintain the peg. Countries that fixed their exchange rates to others often did so because their monetary policy was unstable (perhaps because the fiscal authorities ran unfunded deficits), causing substantial inflation. Fixing the exchange rate brings with it instant credibility, thereby reducing instability and allowing the economy to function again. At some point, unless the country is highly linked to (and in sync with) the core country, the fixed exchange rate will be reconsidered. Does the country want to have independent monetary policy or continue to use the monetary policy of the core country? Either path comes with costs and benefits. This document is authorized for use by hao xie, from 1/11/2016 to 3/3/2016, in the course: MBA 7294: Advanced Financial Analysis - John Bish (Spring 2016), Wilmington University. Any unauthorized use or reproduction of this document is strictly prohibited. -3- UVA-GEM-0108 Types of Currency Crises Next, Rodrigo wanted to review the types of currency crises that had occurred in the past. Currency crises can occur in any country, whether developed or developing. That said, they occur more frequently in emerging markets, so a short description of the \"typical\" emerging market is useful. While reforms have transformed the economies of many developing countries, most have had (if not now, then in the past) some of the following features:1 1. Extensive government control of the economy. This can include international trade restrictions, capital controls, government ownership of firms, and a high level of government spending. The need to circumvent such governmental involvement breeds rent-seeking behavior. 2. High inflation. Tax revenues are typically far too small to cover the government's expenditures and it is often difficult to broaden the tax base, so many developing countries have printed money to finance spending. 3. Domestic financial markets are marked by weak credit institutions, poor bank supervision, weak legal framework, and insufficient regulations. The financial intermediation processthe act of directing savings to their most efficient usedoes not function well. 4. Exchange rates tend to be pegged or heavily managed. 5. Exports are skewed toward natural resources or agricultural commodities (Russian oil, South African gold, Chilean copper, etc.). From these characteristics, if we assume that capital is allowed to flow freely, it is clear why emerging markets are susceptible to currency crises. From Mundell's Trinity, if there are uninhibited capital flows, then loose monetary policy (often owing to the need to finance large fiscal deficits) is inconsistent with a fixed exchange rate. One solution is to impose capital controls, but the country might want to allow capital to flow freely. To date, currency crises have come in three varieties.2 First-generation models The first-generation or canonical model came out of work done on commodity price stabilization schemes by Dale Henderson and Stephen Salant at the Federal Reserve Board in the 1 A similar list can be found in Chapter 22 of Paul Krugman and Maurice Obstfeld, International Economics: Theory and Policy, 7th ed. (Pearson Addison Wesley, 2006). 2 The description of the three varieties of crises is based on Paul Krugman's writings on currency crises, available at http://www.pkarchive.org/crises/crises.html (last accessed July 27, 2011). This document is authorized for use by hao xie, from 1/11/2016 to 3/3/2016, in the course: MBA 7294: Advanced Financial Analysis - John Bish (Spring 2016), Wilmington University. Any unauthorized use or reproduction of this document is strictly prohibited. -4- UVA-GEM-0108 1970s that was later applied to the currency crisis setting by Paul Krugman (1979)3 and Robert Flood and Peter Garber (1984).4 The basic idea behind the first-generation models is that there is some inconsistency between domestic economic policies and the exchange rate policy. Consider, for example, the case in which a government is running large fiscal deficits and printing money to finance them. If the currency were allowed to float freely, it would be natural for it to depreciate. But if the government is not allowing the currency to floatfor example, if it is pegging it to the dollar by using its reservesthere is a disconnect between domestic policies (large deficits financed by printing money) and the exchange rate policy (maintaining a peg). The crisis comes about when speculators force the issue. Speculators know that at some point the government will run out of reserves. When reserves reach some critical level, speculators sell domestic currency and buy foreign currency. This speeds up the loss in reserves and brings about the currency crisis, forcing the government to abandon the peg and devalue. Speculators force the issue in the first-generation model, but the underlying cause is a disconnect between the government's domestic and external policies. Second-generation models First-generation models assume the government is mechanically following a domestic policy of budget deficits financed by the (inflationary) printing of money. Second-generation models recognize that government policy is a bit more complicated than that by allowing for a tension in government policyabandoning the peg has both positive aspects that are attractive to the government and costs that make it unattractive. Further, the costs of maintaining the peg increase when people expect it might be abandoned. For example, a country with a fixed exchange rate might want to undertake expansionary monetary policy (to spur an economy in the doldrums or maybe to inflate away domestic debt). If the country has uninhibited capital flows, Mundell's Trinity says it must give up the pegged exchange rate. Easy enough, but at the same time, the government might be hesitant to give up the peg because perhaps the fixed rate facilitated international trade and investment or devaluations have been very inflationary in the past. Finally, the cost of maintaining the peg increases as speculators think the peg might be abandoned; the government will increase shortterm interest rates to defend the peg, but higher short rates are themselves very costly. In this setting, speculators will attack the currency well before the government runs out of reserves. The second-generation models are very much like the first-generation ones; the primary difference is that by recognizing tensions in government policies, second-generation models are 3 Paul Krugman, \"A Model of Balance of Payments Crises,\" Journal of Money Credit and Banking 11 (1979): 311-25. 4 Robert Flood and Peter Garber, \"Collapsing Exchange Rate Regimes: Some Linear Examples,\" Journal of International Economics 17 (1984): 1-13. This document is authorized for use by hao xie, from 1/11/2016 to 3/3/2016, in the course: MBA 7294: Advanced Financial Analysis - John Bish (Spring 2016), Wilmington University. Any unauthorized use or reproduction of this document is strictly prohibited. -5- UVA-GEM-0108 more realistic. The bottom line with both first- and second-generation models, though, is that the crisis, while sparked by speculators, owes to inconsistencies in policies. Third-generation models Some crisis modelsthe so-called self-fulfilling, herding, and contagion models (otherwise known as third-generation models)put the blame squarely on speculators. A selffulfilling crisis occurs when the country's policies are not necessarily inconsistent with a fixed exchange rate, but some speculators think they might be and thus sell the domestic currency. If enough speculators sell, a crisis can come about even if the fundamentals are relatively sound. What triggers a self-fulfilling crisis? Anything investors think might be relevant. A crisis can also come about because of herding. If a presumably informed trader sells the currency, other less-informed traders might follow; if enough do so, a currency crisis occurs. Contagion can cause a crisis in a healthy country if global investors retrench from all emerging markets, either because they perceive a fundamental link between emerging markets or because their portfolio losses dictate a general retrenchment. Soros versus the Bank of England (BOE) The United Kingdom was in a tough spot in 1992. It joined the European Exchange Rate Mechanism (ERM) late, in June 1990, when its unemployment rate had been on a wonderful downward march from 11% in the mid-1980s all the way down to 5%, its budget was in surplus, and its economy was entering the tenth year of a long expansion. But by mid-1992, the economy was in its second consecutive year of recession, unemployment was 10% and increasing (top half of Exhibit 1), its international competitiveness was eroding (bottom half of Exhibit 1), and the recent budget surpluses had quickly turned into sizable budget deficits (Exhibit 2). The British government had two types of straitjackets. Normally it might want to institute expansionary fiscal policy. But its fiscal deficit was already large and getting larger. Ordinarily, the BOE might want to implement expansionary monetary policy and allow the pound to depreciate. But there, the constraint was the ERM. In 1992, Germany was the center of the ERM. All other ERM members had to, in practice, peg their exchange rates to the deutsche mark. \"Peg\" was not completely accurate; the currencies were allowed to fluctuate, but only within a small band (2.25% from a parity rate for most countries, 6% for more wayward ones). The relationship between the French franc and German mark (Exhibit 3) was apparent for other country pairs: the periphery country's exchange rate would depreciate (perhaps because of overly expansionary monetary policy) and move above the central parity rate, and then the parity rates would be reset. In 1980, the official parity rate between the franc and the mark was 2.356 francs per mark. By 1992, it was 3.35. After the reunification of East and West Germany, the government of the new Germany began a program of massive fiscal expansion to help the East adjust to reunification. By 1991, the expansionary fiscal policy was pushing up German prices (Exhibit 4). Germany's central This document is authorized for use by hao xie, from 1/11/2016 to 3/3/2016, in the course: MBA 7294: Advanced Financial Analysis - John Bish (Spring 2016), Wilmington University. Any unauthorized use or reproduction of this document is strictly prohibited. -6- UVA-GEM-0108 bank, the incredibly inflation-averse Bundesbank, was getting nervous. The Bundesbank had been periodically raising rates in an attempt head off inflation. But it feared it was losing the battle; in early 1992, inflation was over 6%, well beyond the Bundesbank's comfort zone. On July 16, 1992, it raised its discount rate by a full 75 basis points to 8.75%, far above the preunification low of 2.5%. What was the United Kingdom to do? It could implement expansionary fiscal policy, but its budget deficit was already too large. It could implement contractionary monetary policy, but if anything, the BOE still favored looser monetary policy. Two years of recession had brought inflation down to comfortable (for the United Kingdom) levels (Exhibit 4) and allowed the BOE to bring interest rates down in an attempt to spur the economy (Exhibit 5, top half). Should the BOE continue to favor expansionary monetary policy (i.e., should its monetary policy be independent of external factors such as the exchange rate and instead focus on internal economic considerations), or should the BOE tighten to maintain the peg (and disregard domestic conditions)? A decision would have to be made quickly. The pound had been depreciating against the deutsche mark (Exhibit 5, bottom half) and was nearing the edge of the ERM's band. In September 1992as voters all around Europe were reconsidering their commitment to European unityspeculators, led by George Soros, stepped up their attacks on the pound and other European currencies.5 Sweden had to raise its overnight rate to 75% to defend the krona (Exhibit 6, top half). The BOE chose another path of defense; rather than raising interest rates, it chose to use its foreign exchange (FX) reserves to defend the pound. In September 1992 alone, the BOE ran through (U.S. dollars) USD3 billion in FX reserves (Exhibit 6, bottom half) in an attempt to maintain the peg to the deutsche mark. The attack succeeded. The British government left the ERM on September 16, 1992. And the pound, which had been as high as 2.9 deutsche marks per pound in early summer, promptly fell to 2.4 (Exhibit 7). As some would say, Soros broke the BOE and left the ERM in tatters. Hedge Funds versus the HKMA: A Failed Attack Fast-forward five years to late 1997. A virus began in July with the Thai baht. Thailand had, over the course of the 1990s, deregulated its financial markets, opened up to international capital flows, attracted a great deal of capital flows, borrowed heavily in international currencies, and, after all of the good projects were fully funded, began to use the borrowed funds to spur a 5 This \"attack\" can be thought of simply as speculators borrowing in one currency (say, the pound) and using those borrowed funds to purchase another (the deutsche mark). Profits are made if the cost of this strategy (the pound interest rate) is exceeded by the profits (pound depreciation plus deutsche mark interest). Losses arise if the deutsche mark does not appreciate enough (or depreciates) to cover the difference of pound and deutsche mark interest payments. This document is authorized for use by hao xie, from 1/11/2016 to 3/3/2016, in the course: MBA 7294: Advanced Financial Analysis - John Bish (Spring 2016), Wilmington University. Any unauthorized use or reproduction of this document is strictly prohibited. -7- UVA-GEM-0108 real estate boom. Being pegged to the U.S. dollar while the dollar was depreciating against most other currencies (Exhibit 8) was stimulative; being pegged to the dollar when it began to appreciate would, all else equal, slow down the Thai economy. And slow it did. And the highly leveraged economy began to crack. Both foreigners and Thais began to exit Thai markets, the Bank of Thailand went through all of its reserves defending the peg, and on July 2, 1997, it gave up the fight and allowed the baht to float. It promptly plummeted. The virus spread quickly to other Asian currencies such as the Indonesian rupiah, Malaysian ringgit, and Korean won, all of which shared common features with the baht. All had similar problems, all were more or less pegged to the U.S. dollar, all were attacked in 1997, and, after many of the countries both raised rates and went through their international reserves, all promptly plummeted after the peg was abandoned (Exhibit 9, top panel). One Asian currencythe Hong Kong dollardid not plummet (Exhibit 9, bottom panel). It shared some features with its neighborsa peg to the U.S. dollar, soaring real estate and stock pricesand it suffered during the attacks, as its interest rates rose sharply, its stock market plummeted, and it slid toward recession (Exhibit 10). But Hong Kong had a fundamentally different exchange rate policy from the Asian peggers (or the ERM countries, or most countries, for that matter). In 1983, amid political turmoil and a sharp decline in the value of its currency, it put in place a true currency board, pegging the Hong Kong dollar at about 7.8:1 against the U.S. dollar (Exhibit 11). With the currency board, any change in the monetary base had to be matched by a corresponding change in international reserves. That is, instead of active monetary policy, Hong Kong's central bank (the Hong Kong Monetary Authority, or HKMA), had an automatic selfregulating mechanism serve as its policy. As money flowed in from abroad, the monetary base expanded, which drove down interest rates, which made money less likely to flow in, which drove down the monetary base, which drove up interest rates, which attracted money from abroad, which allowed the monetary base to expand, which drove down interest rates, which made money less likely to flow in, which drove down the monetary base, which drove up interest rates, which attracted money from abroad, which allowed the monetary base to expand, which drove down interest rates, which made money less likely to flow in, which drove down the monetary base, which drove up interest rates, which attracted money from abroad, which allowed the monetary base to expand, which drove down interest rates, which made money less likely to flow in. Dizzying, but once the currency board was set up, it required no policy decisions at all. The HKMA could just sit back and change the monetary base as changes in international reserves dictated. As a practical matter, the HKMA had to stand willing to exchange Hong Kong dollars for U.S. dollars at a 7.8:1 ratio. If someone wanted to sell a Hong Kong dollar, the HKMA had to be willing to give them about 13 U.S. cents. If someone wanted to use U.S. dollars to buy Hong Kong dollars, the HKMA had to be prepared to give 7.8 Hong Kong dollars to them for every one U.S. dollar. The Hong Kong dollar was attacked four times in 1997 and 1998 (Exhibit 12, top panel). The first came when the Taiwan dollar depreciated in October 1997. There was great speculation This document is authorized for use by hao xie, from 1/11/2016 to 3/3/2016, in the course: MBA 7294: Advanced Financial Analysis - John Bish (Spring 2016), Wilmington University. Any unauthorized use or reproduction of this document is strictly prohibited. -8- UVA-GEM-0108 that the Hong Kong government would abandon the currency board. Money flowed out of the country, and some speculators funded themselves in Hong Kong dollars (i.e., borrowed locally in Hong Kong dollars) and then sold them for U.S. dollars. Overnight rates spiked (briefly) to almost 300% late in the month. The spike in interest rates raised borrowing costs, thus making further speculative funding in Hong Kong dollars costly, and the attack ended. And the Hang Seng Index (HSI) plummeted. A second attack occurred in early 1998. Again, rates spiked, raising borrowing costs, thus making further speculative funding in Hong Kong dollars costly, and the attack ended. And the HSI plummeted. Two more attacks (in early and late summer 1998) had similar dynamics. In the end, the currency board stood firm, the Hong Kong dollar remained at 7.8:1 versus the U.S. dollar, but defending the attacks had taken its toll on the Hong Kong economy. The HSI, which peaked at over 16,000 just a year earlier, had lost half its value, and the countryso dependent on services, especially the interest-rate sensitive property sectorwas in a deep recession (Exhibit 12, bottom panel). Other Asian countries had devalued in the face of speculative attacks. Hong Kong, with its currency board and somewhat stronger fundamentals, was able to defend itself longer than any other. But the toll on the economy was difficult for the Hong Kong government to stomach. Then the game changed. The HKMA learned of dinners in New York at which big speculators were colluding against the Hong Kong economy. Not only were they funding in Hong Kong dollars and selling them for U.S. dollars (which was becoming costly, because they had to pay the carry but were not getting any movement on the currency), they also sold short HSI futures (to profit from selloffs in equities when interest rates spiked), and they were also colluding. As Joseph Yam, head of the HKMA, said on August 24, 1998:6 It is very well known to almost everyone in the market that a handful of hedge funds have on each occasion conducted a double play in the stock futures market and the currency market. We have come to realize how this double play works, although it has only become apparent, at least to us, in the third and fourth attacks in June and August this year respectively. On each occasion, interbank interest rates were pushed higher, to varying degrees, with a view to engineering a sharp fall in the stock index futures. While the August episode is still being played out, it is clear that these currency attacks, or manipulations, have introduced a large interest rate premium for the Hong Kong dollar over the U.S. dollar. This currency manipulation premium amounts to around three to four percentage points. With the community already in considerable pain, having to go through the inevitable, and already very sharp, economic adjustment necessitated by financial turmoil in Asia, we can do without the pain being disproportionately exacerbated by those manipulating our currency 6 Joseph Yam speech, \"Intervention True to Guiding Policy,\" August 24, http://www.info.gov.hk/hkma/eng/speeches/speechs/joseph/speech_240898b.htm (accessed July 27, 2011). This document is authorized for use by hao xie, from 1/11/2016 to 3/3/2016, in the course: MBA 7294: Advanced Financial Analysis - John Bish (Spring 2016), Wilmington University. Any unauthorized use or reproduction of this document is strictly prohibited. 1998, -9- UVA-GEM-0108 in order to benefit from their short stock futures positions. There is further the serious risk of this double play creating a situation of over-shooting in the stock and other asset markets, undermining the stability of our otherwise robust financial system. Upon learning about the \"double play,\" and especially of the collusion among hedge funds, the Hong Kong government decided that the old rules no longer applied. Hong Kong, long a bastion of non-interventionism, decided it was time to meet the speculators on their terms. Even if the government was somehow able to defend the peg, the double play stood to be profitable if the HSI continued to drop. So on August 14, the government bought a bit of each of HSI's constituent stocks. And a bit more on the 15th. The speculators, seeing the small increase in the HSI as a great opportunity to sell more, doubled down. The government then, having sucked the speculators in, went on a massive buying spree that lasted the final two weeks of Augustthe final two weeks of the August HSI futures contract that the speculators were in using up about USD15 billion (or about 15% of all of its international reserves) to purchase constituent stocks and enter into long HSI futures positions. By the end of the month, the government had become the single largest shareholder of Hong Kong equities; it owned 7.3% of the HSI's 33 constituent companies. And it won: With the HSI up 10% the second half of the month, the speculators were beaten soundly. Many blasted the Hong Kong government for its actions. People complained that Hong Kong would cease to be an international financial center because financial firms would not stand for direct government intervention in markets. Others complained of conflict-of-interest issues, with the government now the largest shareholder of some of the country's largest firms. The Hong Kong government was less concerned. The HSI recovered, increasing the value of its (Hong Kong dollars) HKD120 billion equity position to about HKD160 billion in just a few months. Now it just wanted to figure out how to unload its shares without tanking the market.7 7 To unload its position, the government created the Tracker Fund (http://www.trahk.com.hk/eng/), a fund that tracks the HSI (there was no spot Hang Seng index). The Hong Kong retail market (among others) enthusiastically bought into the fund. This document is authorized for use by hao xie, from 1/11/2016 to 3/3/2016, in the course: MBA 7294: Advanced Financial Analysis - John Bish (Spring 2016), Wilmington University. Any unauthorized use or reproduction of this document is strictly prohibited. -10- UVA-GEM-0108 Exhibit 1 CURRENCY CRISES IN THE UNITED KINGDOM AND HONG KONG UK Unemployment, GDP Growth, and Real Exchange Rate U.K.: Unemployment Rate %, NSA U.K.: Real Gross Domestic Product % Change - Year to Year 12.5 12.5 GDP UR 10.0 10.0 7.5 7.5 5.0 5.0 2.5 2.5 0.0 0.0 -2.5 82 83 84 85 86 87 88 Sources: International Monetary Fund /Haver Analytics 89 90 91 -2.5 92 U.K.: Trade-Weighted Real Exchange Rate CPI-based, 2005=100, increase is real appreciation 100 100 95 95 90 90 85 85 80 80 75 75 70 70 82 83 84 85 86 87 88 Source: International Monetary Fund /Haver Analytics 89 90 91 92 Last data point: June 1992. This document is authorized for use by hao xie, from 1/11/2016 to 3/3/2016, in the course: MBA 7294: Advanced Financial Analysis - John Bish (Spring 2016), Wilmington University. Any unauthorized use or reproduction of this document is strictly prohibited. -11- UVA-GEM-0108 Exhibit 2 CURRENCY CRISES IN THE UNITED KINGDOM AND HONG KONG UK Budget Balance UK: Budget Deficit as a percent of GDP 2 2 0 0 -2 -2 -4 -4 -6 -6 -8 -8 82 83 84 85 86 87 88 89 90 91 92 Source: Haver Analytics Note: Negative is a budget deficit, positive is a budget surplus. Last data point: June 1992. This document is authorized for use by hao xie, from 1/11/2016 to 3/3/2016, in the course: MBA 7294: Advanced Financial Analysis - John Bish (Spring 2016), Wilmington University. Any unauthorized use or reproduction of this document is strictly prohibited. -12- UVA-GEM-0108 Exhibit 3 CURRENCY CRISES IN THE UNITED KINGDOM AND HONG KONG ERM Parity Rate and Bands of Fluctuations: Francs per Mark 3.6 3.4 3.2 3 2.8 2.6 2.4 2.2 2 197912 198012 198112 198212 198312 198412 198512 198612 198712 198812 198912 199012 199112 Note: Shown are the actual francs-per-mark rate as well as the official parity rate (dashed line) and 2.25% bands around the parity rate (outer bands). Parity rates are from http://epp.eurostat.ec.europa.eu/cache/ITY_SDDS/Annexes/ert_erm_esms_an5.pdf (accessed July 25, 2013). Last data point: June 1992. This document is authorized for use by hao xie, from 1/11/2016 to 3/3/2016, in the course: MBA 7294: Advanced Financial Analysis - John Bish (Spring 2016), Wilmington University. Any unauthorized use or reproduction of this document is strictly prohibited. -13- UVA-GEM-0108 Exhibit 4 CURRENCY CRISES IN THE UNITED KINGDOM AND HONG KONG Inflation Rates (year-over-year changes in CPIs) 25% 20% 15% Germany 10% UK 5% 0% Last data point: June 1992. This document is authorized for use by hao xie, from 1/11/2016 to 3/3/2016, in the course: MBA 7294: Advanced Financial Analysis - John Bish (Spring 2016), Wilmington University. Any unauthorized use or reproduction of this document is strictly prohibited. 1992 1991 1990 1989 1988 1987 1986 1985 1984 1983 1982 1981 1980 -5% -14- UVA-GEM-0108 Exhibit 5 CURRENCY CRISES IN THE UNITED KINGDOM AND HONG KONG UK and German 3-Month Rates and the Exchange Rate 3-month Libor: UK and Germany % 17.5 17.5 UK Germany 15.0 15.0 12.5 12.5 10.0 10.0 7.5 7.5 5.0 5.0 2.5 2.5 82 83 84 85 86 87 88 Sources: International Monetary Fund /Haver Analytics 89 90 91 92 Exchange Rate: Pounds per DMark 0.40 0.40 0.36 0.36 0.32 0.32 0.28 0.28 0.24 0.24 0.20 82 83 84 Source: Haver Analytics 85 86 87 88 89 90 91 0.20 92 Last data point: June 1992. This document is authorized for use by hao xie, from 1/11/2016 to 3/3/2016, in the course: MBA 7294: Advanced Financial Analysis - John Bish (Spring 2016), Wilmington University. Any unauthorized use or reproduction of this document is strictly prohibited. -15- UVA-GEM-0108 Exhibit 6 CURRENCY CRISES IN THE UNITED KINGDOM AND HONG KONG Nordic 3-Month Rates and UK Reserves Sweden: STIBOR: 3-months AVG, % per annum Norway: NIBOR Rate: 3-Month % 32 32 Norway Sweden 28 28 24 24 20 20 16 16 12 12 8 8 89 90 91 92 Sources: Sveriges Riksbank, Norges Bank /Haver Analytics U.K.: Foreign Exchange Reserves Change - Period to Period Mil.US$ 4000 4000 2000 2000 0 0 -2000 -2000 -4000 -4000 91 Source: International Monetary Fund /Haver Analytics 92 Last data point: September 1992. This document is authorized for use by hao xie, from 1/11/2016 to 3/3/2016, in the course: MBA 7294: Advanced Financial Analysis - John Bish (Spring 2016), Wilmington University. Any unauthorized use or reproduction of this document is strictly prohibited. -16- UVA-GEM-0108 Exhibit 7 CURRENCY CRISES IN THE UNITED KINGDOM AND HONG KONG The Deutsche Mark/Pound Rate Exchange Rate: Germany/United Kingdom DM/Pound 3.4 3.4 3.2 3.2 3.0 3.0 2.8 2.8 2.6 2.6 2.4 2.4 92 91 90 89 Source: Federal Reserve Bank of New York/Haver Analytics Last data point: October 1992. Exhibit 8 CURRENCY CRISES IN THE UNITED KINGDOM AND HONG KONG The Real Trade-Weighted U.S. Dollar Real Broad Trade-Weighted Exchange Value of the US$ Mar-73=100 130 130 120 120 110 110 100 100 90 90 80 80 80 85 Source: Federal Reserve Board /Haver Analytics 90 95 This document is authorized for use by hao xie, from 1/11/2016 to 3/3/2016, in the course: MBA 7294: Advanced Financial Analysis - John Bish (Spring 2016), Wilmington University. Any unauthorized use or reproduction of this document is strictly prohibited. -17- UVA-GEM-0108 Exhibit 9 CURRENCY CRISES IN THE UNITED KINGDOM AND HONG KONG Asian Currencies Dollar vs. Asian Currencies Jan. 1995=100, up is USD strength 450 450 Indonesian Rupiah Malaysian Ringgit Thai Baht Korean Won 375 375 300 300 225 225 150 150 75 75 0 0 87 88 89 Sources: WSJ /Haver 90 91 92 93 94 95 96 97 Foreign Exchange Rate: Hong Kong Hong Kong Dollar/US$ 10 10 8 8 6 6 4 4 2 2 0 0 87 88 89 90 91 92 93 Source: Federal Reserve Board /Haver Analytics 94 95 96 97 This document is authorized for use by hao xie, from 1/11/2016 to 3/3/2016, in the course: MBA 7294: Advanced Financial Analysis - John Bish (Spring 2016), Wilmington University. Any unauthorized use or reproduction of this document is strictly prohibited. -18- UVA-GEM-0108 Exhibit 10 CURRENCY CRISES IN THE UNITED KINGDOM AND HONG KONG Hong Kong Overnight Rate, Equity Prices, and Real GDP Hong Kong: Hang Seng Stock Price Index 7/31/64=100 Hong Kong: Overnight Interbank Offered Rate % 18000 30 Overnight Rate Hang Seng 16000 25 14000 20 12000 15 10000 10 8000 5 6000 0 94 Sources: HSI, HKMA /Haver 95 96 97 Hong Kong: Real Gross Domestic Product % Change - Year to Year 20 20 16 16 12 12 8 8 4 4 0 0 -4 -4 87 88 89 90 91 92 93 94 95 96 97 Source: International Monetary Fund /Haver Analytics This document is authorized for use by hao xie, from 1/11/2016 to 3/3/2016, in the course: MBA 7294: Advanced Financial Analysis - John Bish (Spring 2016), Wilmington University. Any unauthorized use or reproduction of this document is strictly prohibited. -19- UVA-GEM-0108 Exhibit 11 CURRENCY CRISES IN THE UNITED KINGDOM AND HONG KONG Hong Kong Exchange Rate Hong Kong: Exchange Rate HK$/US$ 8.25 8.25 7.50 7.50 6.75 6.75 6.00 6.00 5.25 5.25 4.50 4.50 80 85 90 Source: International Monetary Fund /Haver Analytics 95 This document is authorized for use by hao xie, from 1/11/2016 to 3/3/2016, in the course: MBA 7294: Advanced Financial Analysis - John Bish (Spring 2016), Wilmington University. Any unauthorized use or reproduction of this document is strictly prohibited. -20- UVA-GEM-0108 Exhibit 12 CURRENCY CRISES IN THE UNITED KINGDOM AND HONG KONG The Attacks Hong Kong: Hang Seng Stock Price Index 7/31/64=100 Hong Kong: Overnight Interbank Offered Rate % 18000 28 Overnight Rate Hang Seng 16000 24 14000 20 12000 16 10000 12 8000 8 6000 4 Sources: HSI, HKMA /Haver 97 98 Weekly data ending September 1998. Hong Kong: Real Gross Domestic Product % Change - Year to Year 12 12 8 8 4 4 0 0 -4 -4 -8 -8 -12 -12 88 89 90 91 92 93 94 95 96 97 98 Source: International Monetary Fund /Haver Analytics This document is authorized for use by hao xie, from 1/11/2016 to 3/3/2016, in the course: MBA 7294: Advanced Financial Analysis - John Bish (Spring 2016), Wilmington University. Any unauthorized use or reproduction of this document is strictly prohibited