Pegged Exchange Rate and Floating Exchange Rate

Case Study 1

From the case study, the export and import dealings between the US-based manufacturer, Blades, manufacturer of roller blades, and Thailand led to weak economic conditions in Asia. This scenario is a clear indication that most countries opt for a pegged rate regime in order to manage import and export trade. Pegging the Thai Baht to the U.S. dollar an approach that the Thai government finds appropriate for controlling its domestic currency so that the exchange rate can be kept at a lower level.

There are; however, of a number of effects that such a peg could have on the U.S.’s level of inflation and the level of exports and imports from Thailand. Pegging the Thai Baht to the US dollar will help improve the competitiveness of rubber and plastic components that Thailand exports to the U.S. Since the decision was meant to keep the exchange rate at a low level, the rubber and plastic components exported by Thailand will have increased competitiveness in US and still be profitable at the domestic level (Klein & Shambaugh, 2012). Besides, pegging the Thai Baht to the U.S. dollar will prevent exchange swings that can easily have adverse effects on the Thailand’s economic outlook.

For manufacturing companies such as Blades, a fixed exchange rate will have a number of effects on them in various ways. First, the downside of an inflation is that companies such as Blades that import raw materials and export finished products will experience an escalation in the cost of buying raw materials (Klein & Shambaugh, 2012). In the long-run, fixed rates will reduce the profit margin of such companies. Besides, a fixed exchange rate can be significant for helping manufacturing firms to plan ahead because of the already future costs.

Case Study 2

Assessment of potential arbitrage opportunities that Blades, a U.S. manufacturer of roller blades has chosen Thailand as its primary export target for Speedos, Blade’s primary products. It is significant to note that there are various advantages and disadvantages that are associated with floating exchange rate system in Thailand. In regard to the advantages, the first one is that floating exchange system offer protection external shocks. Allowing the exchange rate to float enables it to have real-time response to shocks that originate from outside such as sudden rises in oil prices (Klein & Shambaugh, 2012). Second, floating exchange system will enable Thailand to eradicate policy constraints. Therefore, the government will be less worried about the conflict between its domestic economic policies and its external policies. Third, a floating exchange rate help the government compensate for any balance of payments deficit when it depreciates. There are, also, a number of disadvantages that are associated a floating exchange rate system in Thailand. First, floating exchange rates are usually unstable, which can cause a lot of uncertainties for firms. Second, the government can be influenced to pursue the wrong domestic policies due to lack of constraints on domestic policy (Klein & Shambaugh, 2012). Third, existence of speculation can influence changes in the exchange rates, which do not relate to the underlying trade pattern.

A floating exchange rate system affects companies such as Blades in such a way that it exposes them to the risk of making losses. Besides, it subjects such companies to considerable variability in their earnings and this is because of their engagement in international operations (Klein & Shambaugh, 2012). This, therefore, provokes the management of such companies to always be concerned with evaluating and measuring the risk of foreign exchange exposures in order to protect the company against such possibilities.

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