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Assessment of Future Exchange rate Movement
How to measure the percentage changes in currency’s value
A change in the value of a given currency is basically the movement in its value relative to the value of another currency’s value usually the US dollar unless as may be stated otherwise. Ordinarily, a change is the movement from the initial value of a currency to the current value, and that this difference measures and represents the change factor. However, to express this as a percentage, the change in value over a given period is divided by the initial rate.
This ratio is the final rate of change in value of the currency usually expressed as a percentage. A positive change resulting from the underlying measurement represents an appreciation in the value of a currency while a negative change shows depreciation in its value. The following expression represents a mathematical measurement of percentage changes in value of currency over given time, t.
Percentage change in foreign currency value =(S-St-1)/ St-1 where;
S is the most current spot rate period and St-1 is the spot rate at an earlier period. Using the preceding mathematical approach, we can clearly arrive at the percentage change of the Thai bath’s value given that St-1 =$0.022 and S = $0.026. Hence %change = (0.026-0.022)/0.022 =0.004/0.022*100% =18.18%. This outcome means that the value of baht appreciated by 18.18% between the period under review.
What are the basic factors that determine the value of a currency? In equilibrium, what is the relationship between these factors?
The following are some of the factors that affect the movements in equilibrium exchange rate of currencies in foreign exchange market.
Government Controls
Foreign governments play a significant role in influencing the equilibrium exchange rates in a number of ways. One of the ways through which they accomplish this function is by imposing foreign barriers, intervening (buying and selling of currencies) in the FX market, and influencing their macro-variables such as interest rates, inflation, and income levels.
Interest rates may be influenced by central banks in order to stabilize the value of local currency relative to other foreign currencies. For instance, to improve the value of a country’s currency, the central bank may raise the interest rates thus attracting more deposits from investors. This case prompts an increase in demand for the currency. The result is usually a shift in demand from foreign to local currency, thus an upward pressure on local currency. On the other hand, an increase in a country’s level of income results in an increase in demand for imports. Importation that rises leads to an increase in demand for foreign currency more than local currency hence depreciation in value.
Expectations in the Market
Like other financial markets, FX markets react to new information in the market which may have a future bearing on the market situation. A situation that informs the domestic public and foreign investors about a potential surge in the value of a currency would stimulate precipitated sale of that currency. This trend eventually results in downward pressure on the domestic currency, hence low exchange rate due to exaggerated supply on the foreign market. Many corporate investors such as banks and insurance firms obtain currency positions based on the future forecasts in movement of interest rates.
Relative Income levels
Income levels of a country affect the overall demand of imports which has the potential to affect the exchange rates. A summing a substantial rise in the levels of income of Thai population relative to US, this would mean an impact on three items.
They include demand schedule for US dollars, supply schedule for baths for sale, and the equilibrium exchange rate. Firstly, the demand schedule for dollars will shift outwardly reflecting an increase in income of Thai hence an increased demand for US goods. Secondly, the supply schedule for Thai’s baths for sale would not change; hence the equilibrium exchange rate of the US dollar is expected to experience a rise. This scenario remains relevant under an assumption that all the factors are kept constant.
Liquidity
Liquidity affects the sensitivity of the exchange rates with regard to particular transactions. A market scenario experiencing high liquidity would not experience higher sensitivity in its exchange rate when huge purchase or sale of currency is undertaken. As a result, change in the equilibrium exchange rate will be comparably small. Contrary to this, if spot market is more illiquid, its exchange rate becomes n=more volatile hence affecting the equilibrium exchange rate.
How might relativity high levels of inflation affect baht’s value?
Inflation in the Thai economy has a huge bearing on the value baht. During high inflation, the supply of baht in the market becomes generally higher than the market demand. This forces a downward pressure on the demand for baht. In the long run, this would automatically result in depreciation of Thai currency relative to other foreign currencies.
Effect of loss of investor confidence in the Thai baht
Withdrawal of Investor confidence from baht has a negative effect on the value Thai currency. This is because investors will tend to sell most of their baht holdings in favor of other foreign currencies causing a shift in demand for baht in the FX market. Supply would rise significantly resulting in a general low value in baht.
This scenario has an effect on the operations of Blades in Thai market. It will in fact be affected since the exchange rates affects the overall amount of cash flows obtained or received from the exports or from the subsidiary and subsequent amount of cash outflows required to pay for imports. This would lead to a reduction in the profit margins of Blades.
How to prevention of withdrawal of funds in Thai through interest rates
Governments can influence the exchange rate and value of its currency through manipulation of the interest rates. To succeed in this method, Thai government through the central bank can increase the interest rates. This move would eventually seem to be attractive to foreign investors. In this case, the baht’s value would rise due to a shift in demand on the FX market relative to other foreign currencies hence causing an upward pressure for Thai currency (Madura 165).
Standard Deviations in percentage change in Value of currencies
In comparing movements in value of different currencies, measurement using standard deviation becomes the best approach that demonstrates the volatility currency’s value. In measuring the standard deviation, it should be noted that applications are made on the percentage movements as opposed to currency values among currencies.
From the analysis of the Canadian dollar against the Euro, it is found that the standard deviation in Canadian dollar is 4.38% while that of Euro is 1.66%.the standard deviation arrived at indicates that the Canadian dollar is more volatile as compared to the Euro. Additionally, the results indicate that movements in the value of the foreign exchange rates tend towards a larger figure when longer periods are used.
Hence, if yearly periods are applied on exchange rates data, then movements would be much more volatile as indicated in the analysis of each of the given currencies. However the movement tends towards more volatility as the standard deviation becomes larger and larger. Assuming that daily exchange rates are applied and assessed, then movements would be less volatile than as demonstrated, but however, volatility in Canadian dollar would still be higher than that of euro due to its larger deviations.
To maintain stability in the value of Thai’s currency, the government can intervene through foreign exchange market (Madura 192). Under this approach, the government can swap its baht reserves in exchange for foreign exchange reserves via the central bank of Thai. Subsequently, it will utilize its foreign exchange reserves to heavily purchase the baht in the foreign market in order to ease the increasing supply of its currency responsible for its low value.
In doing so, the government would reduce the supply of baht in both domestic and foreign markets, which would stimulate its demand in the long run. By swapping its baht reserves at its central bank, the resultant outcome is manifold; low supply of baht as well as enough foreign reserves that would be beneficial in taking part in foreign transactions.
This mechanism succeeds by establishing an upward pressure on the local Thai currency relative to foreign currencies in the market. This direct intervention results in an overall shift in the demand and supply of the Thai baht in the foreign market. To weaken the foreign currency (or to strengthen the Thai currency), the Thai government exchanges the respective foreign currencies for baht which results in an outward shift in the supply of foreign currency for sale in the FX market.
Does the method succeed?
Usually, such arrangements shall involve agreements to exchange the baht reserves with the foreign currency at a future rate and date. This method can be unsuccessful due to pressure that emanates from the market forces (Madura 192). The effectiveness of this move depends on the ability of the central bank to hold enormous amounts of reserves which it can use (Madura 183).
Internet /excel Exercises
Prevailing currency exchange rate for Japanese yen is 0.0131 as of 21st September 2011.
the prevailing exchange rate of Euro is 1.3707 as of September 21, 2011.
The following simulation demonstrates how to get the number of yen per Euro given the above exchange rate scenario.
1 Japanese yen = $ 0.0131
1euro= $1.3707
Hence, the Number of Japanese yen per euro can be found by finding the ration of euro’s exchange rate relative to that of euro as below.
1.3707/0.0131*1 Yen = 104.634. This means that 1 euro is an equivalent of 104.634 Japanese yen.
from the yahoo table, one euro is an equivalent of 104.69 Japanese yen
to show how many Euros equal one Japanese, we follow the following mathematical approach.
1 euro= 104.69 Yen
Hence, 1Yen = (1/104.69) euros = 0.0096.
whether it is mostly upward or downward and at what points it had an abrupt shift in opposite trend.
From the trend analysis, the trend has mostly been characterized by an upward trend in which the upward increase was eminent in the entire period between 2007 up to the last quarter of 2008. A slight downward trend was observable at end of 2008, but was reversed at start of 2009.
Some of the points that experienced sharp change in trend were during the 9th month of 2008 where the rate moved from about 1.45 to 1.25. Another sharp downward movement was from the start of 2009 with 1.45 to the low of 1.2 during mid 2009.
Blades Case- currency rates
The following calculations would be beneficial in determining the best option to be exercised by Blades given the current spot rate of $0.0131
Given the first exercise price of $0.00756, the premium can be calculated as $0.0131-$0.00756 =$0.00554 which is 42.3% of the total transaction amount that would be paid if the underlying option is exercised. Using the second scenario in which the call price is $0.00792, the premium is $(0.0131-0.00792) = $0.00518 resulting in a premium of 39.54%. This would be the price that Blades would pay per yen if this option is left to prevail. Using the analysis, it seems favorable for Blades to exercise the second option that would result in a low amounts to be paid per Japanese yen for Blades payables.
Should Blades allow its yen to be un-hedged? Describe the tradeoff
Blades should not allow its yen to be un-hedged since an anticipated rise in the value of yen would be mean future scarcity in supply of Japanese yen. Since they have a future obligation of settling their account payables, it is important for Blades to purchase currency call options. This exercise will be beneficial by ensuring higher premiums upon payment of such payables. This is because they shall have accumulated yen reserves through which they are obliged to pay their debts.
Given an assumption that speculators already know the expectations of movement in yen’s value, determine the expectations on both order and delivery dates?
Currency speculations have far reaching impact on exchange market that involves a transfer of currencies between firms. In many cases, currency speculations results in serious currency crises as witnessed during the Vietnam War. Speculations generally affect the spot transactions whose practice varies on a daily basis. Due to this, order and delivery days would have a lower transaction period, usually less than one day in order to capitalize on the anticipated rise in the value of the currency. On the other hand, futures contracts remain less affected since they operate under certain agreements and terms that guide futures contracts.
Due to speculations in the market, the delivery and order dates would generally be impacted since the buyer would be willing to engage in an agreement that would offer an opportunity to hold the currency being speculated. Therefore, time difference between delivery and order dates for futures contracts in this context would be confined within a period of one month in order to allow for an accurate speculation that would yield maximum yield (Madura 192). In general, the duration of the trade would be skewed towards the end of the maximum contract date in order to accomplish for parties to benefit.
Given that the firm consents to the market expectation of an anticipated increase in the value of the Japanese yen, the viable decision would be to engage in hedging of funds in order to capitalize on the market expectation. The outcome would be that premium percentage obtained shall reflect a profit margin due to lesser amount paid in settlement of its accounts payables. A decision to hedge funds in Japanese yen while relying on the fundamentals of cost provides the best approach of deriving an optimal hedging strategy for a given firm.
The alternative selected out of the analysis shows that the average cost of hedging funds would be more desirable. This conclusion is based on the premium percentage reached under the prevailing market conditions and currency expectations. The choice would hence result in an overall optimal hedge strategy given the consensus of Blades with the prevailing market scenario.
Determination of optimal hedge for Blades given that SD for yen is $0.0005, futures price being= $0.006912 and that the spot rate would not go beyond 2 Standard deviations
Here, the spot rate will be equal to 2*$0.0005 = $0.001. There is no difference in the current and futures contract prices and as such, we calculate the outcome as follows:
Optimal hedge, h = 0.006912/ (0.001-0.0005) =0.006912/0.0005=13.824
The analysis indicates that the optimal hedge would be a portfolio of 13.84
Works Cited
Madura, Jeff. International Financial management. New York: Cengage Learning. 2010, Print.
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