Thailands Currency Crisis - Assignment Example

BANK 5028 International Finance Student’s Name Course/Number Instructor’s Name Question 1 [8 marks] In 1997, the South East Asian currency crisis led to the devaluation of many Asian currencies. Most severely impacted was the Thai baht. (a) Briefly outline the main causes and characteristics of Thailand’s currency crisis in 1997. (4 marks) The two characteristics which define a country experiencing a financial crisis are a drop in the currency value and a drop in the traded equity prices. There are however two main interpretations as to what caused the crisis in Asia. One of them is that there was a sudden shift in the market expectations and confidence. This was as a result of panic from the domestic and international investors emphasized by the faulty policy response of the international monetary fund. The other interpretation is that fundamental imbalances of structural and policy distortions in those countries covering that region (Frankel & Kose 1996). Further to this, the moral hazard problem accelerated the financial vulnerability especially due to market liberalization in the 1990’s leading to an exposure of the market fragility with the macroeconomic and financial distress which was experienced in 1997.The crisis exhibited an interrelation between the corporate, financial and the international levels.The corporate level involved political pressures in maintenance of high economic growth rates which had led to public guarantees of private projects but the production plans had overlooked the risks and costs involved in those investment projects which resulted to the profitability of the projects to be low (Asian Development Bank 2003). Under the financial problem, the banks had excessively borrowed from abroad to lend domestically. However, structural distortions of the banking sector such as laxity in supervision, weak regulation capital adequacy ratios which were low, lack of compatible deposit insurance schemes, corrupt lending practices and lack of a market criteria to credit allocation led to the buildup of weaknesses in the financial sector. Internationally, the banks had neglected the standards of sound risk assessment to lend large amounts to the region. The most of the foreign debt was in short term unhedged and foreign currency denominated obligations and that large fraction of the short term liabilities to the foreign reserves was an indicator of financial fragility. (b) What major lessons were learnt from Thailand’s currency crisis about the ways the exchange rate for a currency can be determined? (2 marks) Since the crisis led to bankruptcy of organizations, some of the lessons learnt include: avoidance of vulnerability. This is to be curbed by watching the buildup of leveraged debt financing. Another lesson is that sequencing of financial liberalization is important. Therefore, unless the financial systems are strong and globally competitive, domestic banks are not to be allowed to enter into foreign currency exposures (Radelet & Sachs 2001). Also, the banks developed should rely less on the financial system. This will lead to dissipation of risks if other financing alternatives are adapted such as bond and money markets. Finally, the old government directed industrialization models no longer work as the state connected conglomerates had the highest debt and foreign currency exposures and workable models should therefore be formulated (Radelet & Sachs 2001).. (c) What steps were eventually taken by the Thai government/monetary authority to normalize Thailand’s economy and currency? (2 marks) The IMF was involved in formulation of reform programs which were to address the fiscal, monetary and major external balances. This was done by strengthening the financial systems, improving transparency and governance as well as restoration of economic competitiveness and modernization of legal and regulatory environment (Asian Development Bank 2003). Question 2 [4 marks] You have just started work in the foreign exchange department of a major bank and have been given responsibility for dealing the New Zealand dollar (NZD) and Thai Baht (THB). The following rates (expressed in Moosa textbook format) are currently applying in the market.  NZD/USD 1.3231/1.3926  USD/THB 0.0298/0.0326 (a) If you execute the following trades as a price maker calculate the amount of: (i) NZD you will receive in exchange for USD 500,000 The buying and selling prices are quoted from the price maker’s point of view. Therefore to sell the USD the price taker uses the offer price. NZD/USD = 1.3926 For USD 500,000 the NZD to get are as follows 1.3926NZD = 1 USD = 500,000 × 1.3926 = NZD 696,300 (ii) THB you will receive in exchange for USD 500,000 USD/THB = 0.0326 For USD 500,000 the THB to receive are as follows 0.0326USD = 1 THB = 500,000 ÷ 0.0326 = THB 15,337,423 (iii) USD you will receive in exchange for NZD 1,000,000 To buy the USD the price maker uses the bid price NZD/USD = 1.3231 For NZD 1,000,000 the USD to receive is as follows 1.3231NZD = 1USD = 1000000÷1.3231 = USD 755,800 (iv) USD you will receive in exchange for THB 1,000,000 USD/THB = 0.0298 For THB 1,000,000 the USD to receive is =0.0298USD = 1THB = 1,000,000 × 0.0298 = USD 29,800 (b) If you execute the following trades as a price taker calculate the amount of: The price taker sells the base currency at the bid price and buys at the offer price. (i) NZD you will receive in exchange for USD 500,000 To sell the USD the price taker will use the bid price NZD/USD = 1.3231 For USD500, 000 the NZD to receive is as follows 1.3231NZD = 1USD = 500,000 × 1.3231 = NZD 661,550 (ii) THB you will receive in exchange for USD 500,000 USD/THB 0.0298 For USD 500,000 the THB to receive is as follows = 0.0298USD = 1THB = 500,000 ÷ 0.0298 = THB 16,778,523.50 (iii) USD you will receive in exchange for NZD 1,000,000 The price taker will use the offer price to buy the USD NZD/USD 1.3926 For NZD 1,000,000 the USD to get is 1.3926NZD = 1USD = 1,000,000 ÷ 1.3926 = USD 718,081 (iv) USD you will receive in exchange for THB 1,000,000 USD/THB 0.0326 For THB 1,000,000 the USD to receive 0.0326USD = 1THB = 1,000,000 × .0326 = USD 32,600 Question 3 [2 marks] The following are current spot exchange rates quotations for Pound Sterling (GBP) and Swiss Franc (CHF) (expressed in Moosa textbook format):  GBP/USD 0.6105-0.6250  USD/CHF 1.1279/1.1435 Calculate the CHF/GBP cross rate (i.e. CHF price of one unit of the GBP commodity currency) implied by these spot rates. A cross rate is used when there is stock exchange using different currencies from the country where the quote is given. GBP/USD 0.6105-0.6250 To get USD/GBP, we use the reciprocal value 1÷ 0.6105 & 1 ÷ 0.6250 = 1.6380 & 1.6000 USD/GBP Exchange = 1.6380 Bid; 1.6000 Offer USD/CHF Exchange = 1.1279 Bid; 1.1435 Offer Therefore, he CHF/GBP cross rate is = 1.1279 ÷ 1.6380 Bid & 1.1435 ÷ 1.6000 = 0.6886 Bid & 0.7147 Offer = CHF/GBP = 0.6886/0.7147 Question 4 [6 marks] Trident is a multinational corporation that has operations in several countries. Although Trident is based in the US and its profits are reported in USD, its revenues are denominated in various currencies including the AUD. One year ago Trident took out a 3-year USD 10 million loan at a fixed interest rate of 3.5% per annum to provide working capital for its Australian subsidiary. Since Trident has AUD revenues, it decided to enter in a three year swap to receive USD and pay AUD with the quoted currency swap rate of 5.6% on AUD. The notional amount of the swap was USD 10 million with an exchange rate (expressed in Moosa textbook format) USD/AUD 0.97. (a) Calculate the amount of Trident’s USD loan interest payments (0.5 mark) A = P = 10,000,000 = 10,000,000 × 1.1087 = 11,087,000 Therefore, the interest payments will be = 11,087,000 – 10,000,000 = $1,087,000 (b) Calculate the notional AUD principal and interest amounts under the swap agreement (1 mark) USD/AUD 0.97 = 0.97USD = 1AUD Therefore, the Notional Principal = 10,000,000÷0.97 Principal = AUD 10,309,278 Interest Amounts = 10,309,278 = 10,309,278 × 1.1776 = 12,140,206 Interest payments = 12,140,206 – 10,309,278 Interest = AUD 1,830,928. (c) Draw each the following time lines and identify on them the amount and timing of the respective values. (1.5 marks) (d) One year into the swap agreement, Trident’s operations in Australia have become unprofitable and it has decided to withdraw from the Australian market. Consequently Trident wants to unwind the swap as it no longer has the AUD revenue to service the AUD swap payments. At that time the two year fixed rate on a USD loan is 3.2% per annum and the two year fixed rate on an AUD loan is 5.9% per annum. The spot rate at that time is USD/AUD 0.95. (i) Calculate the present value of the remaining USD swap receipts. (0.5 mark) Remaining USD Interest = 1,087,000 – (10,000,000 × .035) = 1,087,000 – 350,000 = 737,000 PV = = = 692,003 (ii) Calculate the present value of the remaining AUD swap payments. (0.5 mark) Remaining AUD Interest = 1,830,928 – (0 .056 × 10,309,278) = 1,830,928 – 577,320 = 1,253,608 PV = = = 1,117,815 (iii) Calculate the present value (in USD) of the swap to Trident. Hint: the present value of the swap is the difference between the present value of the payments and the present value of the receipts expressed in a common currency. (1 mark) PV of receipts in USD = 692,003 PV of payments in AUD = 1,117,815 USD/AUD 0.95 Therefore, the PV of the swap in USD will be 0.95USD = 1AUD Hence AUD 1,117,815 =? USD = 1,117,815× 0.95 = USD 1,061,924.25 PV of the swap = 692,003 – 1,061,924.25 = -369,921.25 (v) For the swap to be discharged, identify who pays whom what? (1 mark) Trident will pay $369,921.25 because of withdrawing from the swap agreement. References Asian Development Bank, 2003. Asia Economic Monitor 2003, July 2003 update. Frankel, J. and A.K. Kose, 1996. “Currency crashes in emerging markets: an empirical treatment”, Journal of International Economics (41), pp. 351-366 Radelet, S. and Sachs, J., 2001. “Lessons from the Asian Financial Crisis”; Global Financial Crises and Reforms; Cases and Caveats (Routledge, London 2001). . Read More