INBU 4200: International Financial Management



INBU 4200: International Financial Management

Project 2

South Korean Won

Written Report Cover Sheet

Date: April 25, 2006

Team Members*:

Tyler Cicirello

Howard Jiang

Tamara Nozawa

Tom Taylor

*“On my honor, as a University of Colorado at Boulder student, I have neither given nor received unauthorized assistance on this work.”

1) Short term (1 week into the future) using technical analysis

[pic]

Market Momentum Analysis:

Over the pasts three months the South Korean won has exhibited moderate strength. During the past year, the won has shown variation in momentum. From May 2006 to October 2006 the won was generally weak and has steadily declined in value. However, it has rebounded over the past six months and currently appears to be experiencing steady upward momentum.

Moving Average Rules:

The South Korean won crossed its trend line on the way up in December 2005. According to the moving average cross over strategy, this is a signal of currency strength because it has risen above the moving average. It has stayed at a relatively consistent distance above the trend line since the beginning of March 2006.

Bollinger Band Analysis:

In January of 2006 the South Korean won moved above the upper band. According to the Bollinger Band Theory, this is a technical signal of future weakness in the currency. From early January to the middle of February the currency was considered overbought with relatively high spot prices. It appears as though the won could be moving toward the upper band again. If it does climb outside of the upper band, it would again be considered overvalued and this would be a signal of depreciation in the near future.

2) Short term (3 months into the future) using

The asset choice interest rate differential and balance of payments models

The variables for the asset choice pricing model are showing mixed signals for the Won versus the Dollar. What seems to be the driving force behind the strengthening of the Won is the inflow of foreign investment in equities, which have been consistently out-performing US equities (S&P 500), as seen below:

[pic]

Also driving the Won is the Korean Central Bank’s continued raising of their benchmark interest rates to help offset a possible jump in inflation to around 3.3% from the 1.6% rate seen in March. This comes on the heels of news of the possible slowing of interest rate hikes in the U.S.

The signals of a possible weakening of the Won are due to the Balance of Payments model and the interventionist policies and their effects on Korean equities. First, as the Won strengthens against the Dollar, it hurts Korean companies that export goods the US, and exports make up around 40% of South Korea’s economy. What has been a result of this is a current account deficit of $760.7 million compared to a $91.2 million surplus just a month earlier. For example, every 1 Won gain against the dollar can wipe out $20 million in earnings for Samsung Electronics Co., the nation’s largest exporter. This signals that foreigners will start selling their South Korean equities soon, certainly within our 3 month time frame.

The interventionist side of this is the South Korean Central Bank’s realization of the strong Won’s effect on their export-heavy economy. In fact, Rhee Gwang Ju, head of the authority’s international bureau, announced that the Won is “overly strong” against the dollar. This has lead many, like the Korea Development Bank in Seoul, to come to the realization the central bank doesn’t want the Won to go any higher and will start selling Won if, and when, this occurs.

What must be concluded from this is that the Won will not go any higher. It is difficult to say that it will weaken within our 3 month time frame though. I would advise that the Won could only go down from here.

3) Long term (5 years into the future) using the relative purchasing power parity model

Calculations from the relative PPP model suggest that the Korean won will weaken in five years from now. The data gathered from about annual rate of inflations seems very reliable and had been successfully crossed checked with information at the Bank of Korea website about inflationary history since 2001. Therefore this forecast can be considered a reliable relative purchasing power parity forecast. According to the relative purchasing power parity model theory, exchange rates are expected to move in the direction opposite to the inflation differential between the two countries in question. In this case, the Korea has a relatively high inflation rate compared to the United States; therefore the Korean won should experience depreciation in the foreign exchange market.

Current Spot rate for Korean Won = 948.2

Annual rate of inflation in the U.S. = 2.6%

Annual rate of inflation in South Korea = 3.3%

The Korean won should depreciate .7% per year against the US dollar.

Forecasting the spot rate for the won 5 years from now:

PPP Future Spot Rate = 948.2 x (1 + .033)5/ (1 + .026)5

= 948.2 (1.1763)5/ (1.1369)5

= 948.2 (2.2521)/ (1.8994)

= 1124.2715

4) Long term (5 years into the future) using the International Fisher Effect

The IFE model shows that the won will depreciate to 958.0 KRW per USD over a five-year period. Considering that the IFE theory is proven to hold up well over the long run, this forecast should be relatively accurate. The International Fisher Effect (IFE) states that change in exchange rates will be driven by differences in market interest rates between countries. According to the International Fisher Effect, because the won currently has a relatively high interest rate and high inflationary expectations, the currency is expected to weaken. The IFE assumes that the exchange rate will change by a percentage amount equal to the observed market interest rate difference. The Monetary Policy Committee of the Bank of Korea has raised interest rates three times since October 11, 2005 from 3.25% to 4.0% on February 9, 2006. The Bank of Korea has a current inflation target of 2.5%-3.5% in terms of the average annualized rate of inflation.

IFE Spot Rate = Current Spot Rate x (1 + inthome)n/(1 + intforeign)n)

IFE Spot Rate = 948.2 x (1 +.0514)^5 / (1 + .0491)^5

IFE= 948.0 x [(1.2848)/ (1.2708)] = 958.453

1 USD = 958.453 KRW

The Korean won should depreciate .2% per year against the US dollar.

References Cited

Korea 5 year Treasury bond data retrieved from:

United States 5 year Treasury bond data retrieved from:

Spot Rate of Korean won data retrieved from:

Pacific Exchange Rate Services Korean Won Information retrieved from:



Forex Directory Korean Won Information retrieved from:



: South Korea Country Briefing Fact Sheet retrieved from:

: United States Country Briefing Fact Sheet retrieved from:



Bank of Korea Website: Publications on Recent Economic Development retrieved from:



South Korean export and current account information retrieved from:



Korean Central Bank tendencies retrieved from their website and:

on April 24, 2006.

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