At the monthly horizon, investors considering investing in the Thai baht prior t
ID: 3130084 • Letter: A
Question
At the monthly horizon, investors considering investing in the Thai baht prior to its devaluation might assess the following probabilities: 0 with monthly probability Delta S^s/tb/S^s/tb = {0 with monthly probability 1-p =.80 -14% with monthly probability p =.20 For discrete random variables, the expectation (or mean) is computed by weighting the outcomes by the probabilities What is the expected percentage change in the dollar price of Thai baht? Suppose this expectation has been incorporated into the forward premium (or discount) on Thai bah f - s-t/s_t = E[Delta s/s] where F and S are in S/baht. If the spot exchange rate is.040 $/baht (25 baht/4, the former official fixed exchange rate), what is the forward rate in $ baht? In baht/$? Is the baht at a premium or a discount? What does this tell you about using forward rates as a signal of devaluation/revaluation risk?Explanation / Answer
a)Expected Change=0*0.8+0.2*-14=-2.8%------------>e
b)Spot Exchange rate=0.04$/baht
Hence F=S+e*S=0.04-0.04*0.028 =0.03888 $/baht =25.72 baht/$
c)The future value of the baht/$ is greater than the present value of bhat/$,which says the baht is at a premium relative to that of a $,as the value of baht is increasing more than the value of the $.Which means the currency of the country is falling and there is a huge devaluation risk.The prices will rise in the country
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