BLADES, INC.

CASE
Assessment of Future Exchange Rate Movements
1. How are percentage changes in a currencys value measured? Illustrate your answer
numerically by assuming a change in the Thai bahts value from a value of $.022 to
$.026.
The percentage change in the value of a currency is calculated by comparing the spot rates at
two specific time periods.
S tSt 1
S t1

St = Current Spot rate

St-1= Spot rate of the earlier date

A positive change indicates that the currency has appreciated while a negative one denotes
that it has depreciated. Thus the percentage change in foreign currency value is:
$ 0.026$ 0.022
=18.182
$ 0.022
Thus, the Baht would be expected to appreciate by 18.182%
2. What are the basic factors that determine the value of a currency? In equilibrium, what
is the relationship between these factors?
The basic factors that determine the value of a currency are:

The supply of the currency and

The demand of the currency

Like any other product in the market, the price of any currency is determined by these two
forces. The demand schedule is downward sloping because corporations and individuals in
US, for instance, will be encouraged to purchase more Thai goods when the Baht is worth
less and vice versa. There is a positive relationship between value of Baht and quantity of
Baht for sale. When the Baht is valued high, Thai consumers and firms are more likely to
purchase US goods and thus they supply greater number of Baht to the market to be
exchanged for dollars.

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At equilibrium, the quantity of Baht demanded will be equal to the quantity of Baht
supplied. Thus the value of the currency as desired by the investors will be equal to the
value the sellers are ready to give up.
3. How might the relatively high levels of inflation and interest rates in Thailand affect the
bahts value. (Assume a constant level of U.S. inflation and interest rates.)
The Baht would be affected both by inflation levels and interest rates in Thailand relative to
levels of these variables in the U.S.
Senario-1: Trade Flow > Capital Flow
If the trade flow is lower than capital flow, the impact of relative interest rate will be higher
than inflation on currency value.
This high level of interest rates in
Thailand may cause appreciation of the
baht relative to the dollar. A relatively
high level of interest rates in Thailand
would have rendered investments there
more

attractive

for

U.S.

investors,

causing an increase in the demand for

baht. This will lead to an increase in the
Figure 1: Impact of high interest rate

supply of the USD in the Thai economy

and an increase in demand for the Thai
Baht by US investors.

This will lead to a higher equilibrium price or exchange rate for the Thai Baht, meaning that
the value of Thai Baht will appreciate.
A high level of inflation tends to result in currency depreciation, as it would increase the
Thai demand for U.S. goods, causing an increase in the Thai demand for dollars. This will
lead to a fall in demand for locally produced goods in Thailand and increase in demand for
US goods as they will become more expensive in comparison to US goods because the level
of inflation in the US has remained unchanged. This will lead to an increase in demand for
US currency in exchange for the Thai Baht creating a downward pressure on Bahts value.
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Also, US consumers will be less willing to

buy Thai goods as they are more expensive
now causing the supply of the USD to fall in
the Thai economy.

Thus

Figure 2: Impact of inflation

two factors combined will have an upward

pressure on the value of the Baht. This will
lead to a higher equilibrium price or
exchange rate for the Thai Baht, meaning
that the value of Thai Baht will appreciate.

Figure 3: Currency value appreciate

Senario-2: Trade Flow < Capital Flow

If the trade flow is lower than capital flow, the impact of relative inflation will be higher than
interest rate on currency value.
This high level of interest rates in
Thailand may cause appreciation of the
baht relative to the dollar. A relatively
high level of interest rates in Thailand
would have rendered investments there
more

attractive

for

U.S.

investors,

causing an increase in the demand for

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baht. The effect will be quite similar to

previous scenario.

High
inflation
Figure 4: Impact of interest rate

rates

will

lead

to

depreciation of the Baht and high levels of interest will cause

the value of Baht to appreciate.

Figure 5: Impact of inflation

High inflation rates will lead to depreciation of

the Baht and high levels of interest will cause
the value of Baht to appreciate. Thus two factors
combined will have a downward pressure on the
value of the Baht. This will lead to a lower
equilibrium price or exchange rate for the Thai
Baht, meaning that the value of Thai Baht will
depreciate
Figure 6: Currency value depreciate

4.

How do you think the loss of confidence in

the Thai baht, evidenced by the withdrawal of funds from Thailand, will affect the

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bahts value? Would Blades be affected by the change in value, given the primary Thai
customers commitment?
The loss of confidence in the Thai Baht caused investors to withdraw their funds from
Thailand. This will lead to a fall in supply of foreign currencies in Thailand. The demand for
Thai Baht has and will fall due to loss of investors confidence. This will cause the Thai Baht
to be devalued, meaning, the exchange rate for Thai Baht will be lower. This is bad news for
Blade Inc. as they have agreed to sell Speedos at a fixed price denominated in the Thai
currency.
If the value of Thai Baht depreciates, it
means that each unit of the Thai
currency will now fetch fewer US
dollars as opposed to when the Baht was
stronger. This will lead to a loss in
revenue for Blades Inc. and in turn a fall

in

profit level.
However, Blades Inc. imports some of
the components used to manufacture

Figure 7: Effect of loss of confidence on

Thai Baht

Speedos from Thailand. The price of those supplies will fall as a result of the depreciation of
the Thai Baht leading to a lower cost of production for speedos. But that might not be enough
to offset the fall in revenue because not all the components of Speedo are imported from
Thailand. Therefore it is necessary to know what portion of the raw materials come from
Thailand in order to determine its effects on profits. We would also need to know how much
of the sales prices go into paying for costs of production as that will also influence profit
levels significantly before we can reach any conclusion about whether the fall in revenue
from Thailand can be offset by the lower costs of production that was accompanied by the
depreciation of the Thai Baht.
5. Assume that Thailands central bank wishes to prevent a withdrawal of funds from its
country in order to prevent further changes in the currencys value. How could it
accomplish this objective using interest rates?

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Foreign investors from various countries had invested heavily in Thailand to take advantage
of the high interest rates there. As a result of the weak economy in Thailand, however, many
foreign investors have lost confidence in Thailand and have withdrawn their funds which
caused depreciate value of the Thai Baht.
In order to prevent foreign investors from withdrawing their funds, The Bank of Thailand,
the central bank of Thailand, can increase interest rates for foreign investors. As a result, Thai
Baht will appreciate. This will also discourage them from withdrawing their money from
Thailand and also perhaps encourage them to invest further.
We know, Real interest rate= Nominal Interest rate- Inflation
Suppose, the relative interest rate of Baht is increased from 6 to 9 percent. At the same time
suppose, the relative inflation rate increases from 7 to 9 percent. Hence the increase in the
real interest rate is 1 percent (3%-2%). Now, to stop the withdrawal of fund, the real interest
rate of Baht needs to be higher than that of other foreign currencies. This relative real interest
rate must be high enough to mitigate the depressing effect of withdrawal. The following
graph explains this phenomenon:

As a result of the withdrawal of funds, the supply of Baht increased as the foreign investors
are liquidating their accounts. This is shown by the supply curve S 1. Now if the Government
makes real interest rate relatively high in Thailand, the selling pressure on Baht will ease.
The supply of Baht to the investors will decrease as the current holders of Baht will not want
to put them for sell in order to enjoy higher interest rate income. The foreign investors will
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want to make new investments in Baht. Hence the demand curve will shift from D to D 2. The
new equilibrium will be at E1

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