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How are percentage changes in a currency's value measured?

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Solution to Continuing Case Problem: Blades, Inc.;1. How are percentage changes in a currency's value measured? Illustrate your answer numerically by;assuming a change in the Thai bahts value from a value of $0.022 to $0.026.;ANSWER: The percentage change in a currency's value is measured as follows;where S denotes the spot rate, and denotes the spot rate as of the earlier date. A positive percentage;change represents appreciation of the foreign currency, while a negative percentage change represents;depreciation.;In the example provided, the percentage change in the Thai baht would be;That is, the baht would be expected to appreciate by 18.18%.;2. What are the basic factors that determine the value of a currency? In equilibrium, what is the;relationship between these factors?;ANSWER: The basic factors that determine the value of a currency are the supply of the currency for;sale and the demand for the currency. A high level of supply of a currency generally decreases the;currencys value, while a high level of demand for a currency increases its value. In equilibrium, the;supply of the currency equals the demand for the currency.;3. How might the relatively high levels of inflation and interest rates affect the bahts value? (Assume a;constant level of U.S. inflation and interest rates.);ANSWER: The baht would be affected both by inflation levels and interest rates in Thailand relative;to levels of these variables in the U.S. 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. Furthermore, a relatively high level of Thai inflation would reduce the U.S.;demand for Thai goods, causing an increase in the supply of baht for sale.;Conversely, the 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. Furthermore, U.S.;securities would have been less attractive to Thai investors, causing an increase in the supply of;dollars for sale. However, investors might be unwilling to invest in baht-denominated securities if;they are concerned about the potential depreciation of the baht that could result from Thailands;inflation.;4. How do you think the loss of confidence in the Thai baht, evidenced by the withdrawal of funds from;Thailand, will affect the bahts value? Would Blades be affected by the change in value, given the;primary Thai customers commitment?;ANSWER: In general, depreciation in the foreign currency results when investors liquidate their;investments in the foreign currency, increasing the supply of its currency for sale. Blades would;probably be affected by the change in value, as the sales are denominated in baht. Thus, the;depreciation in the baht would have caused a conversion of the baht revenue into fewer U.S. dollars.;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?;ANSWER: If Thailands central bank wishes to prevent further depreciation in the bahts value, it;would attempt to increase the level of interest rates in Thailand. In turn, this would increase the;demand for Thai baht by U.S. investors, as Thai securities would now seem more attractive. This;would place upward pressure on the currencys value. However, the high interest rates could reduce;local borrowing and spending.;6. Construct a spreadsheet illustrating the steps Blades treasurer would need to follow in order to;speculate on expected movements in the bahts value over the next 30 days. Also show the speculative;profit (in dollars) resulting from each scenario. Use both of Ben Holts examples to illustrate possible;speculation. Assume that Blades can borrow either $10 million or the baht equivalent of this amount.;Furthermore, assume that the following short-term interest rates (annualized) are available to Blades;Currency;Dollars;Thai baht;Lending Rate;8.10%;14.80%;Borrowing Rate;8.20%;15.40%;15;16 ANSWER: (See spreadsheet attached.);Depreciation of the Baht from $0.022 to $0.020;1. Borrow Thai baht ($10,000,000/0.022);454,545,454.50;2. Convert the Thai baht to dollars ($454,545,454.50 million $0.022).;10,000,000.00;3. Lend the dollars at 8.10% annualized, which represents a 0.68% return over;the 30-day period [computed as 8.10% (30/360)]. After 30 days, Blades;would receive ($10,000,000 (1 +.0068));10,068,000.00;4. Use the proceeds of the dollar loan repayment (on Day 30) to repay the;baht borrowed. The annual interest on the baht borrowed is 15.40%, or 1.28%;over the 30-day period [computed as 15.40% (30/360)]. The total baht;amount necessary to repay the loan is therefore (454,545,454.50 (1 +.0128));5. Number of dollars necessary to repay baht loan ($THB460,363,636.40 $0.02);6. Speculative profit ($10,068,000 $9,207,272.73);460,363,636.40;9,207,272.73;860,727.27;Appreciation of the Baht from $0.022 to $0.025;1. Borrow dollars.;10,000,000.00;2. Convert the dollars to Thai baht ($10 million/$0.022).;454,545,454.50;3. Lend the baht at 14.80% annualized, which represents a 1.23% return;over the 30-day period [computed as 14.80% (30/360)]. After 30 days;Blades would receive (THB454,545,454.50 (1 +.0123));460,136,363.60;4. Use the proceeds of the baht loan repayment (on Day 30) to repay;the dollars borrowed. The annual interest on the dollars borrowed is;8.20%, or 0.68% over the 30-day period [computed as 8.20% (30/360)].;The total dollar amount necessary to repay the loan is therefore;($10,000,000 (1 +.0068));5. Number of baht necessary to repay dollar loan ($10,068,000.00/$0.025);6. Speculative profit (THB460,136,363.60 THB402,720,000.00);7. Dollar equivalent of speculative profit (THB57,416,363.60 $0.025);10,068,000.00;402,720,000.00;57,416,363.60;1,435,409.09

 

Paper#24681 | Written in 18-Jul-2015

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