Brazilian Real

1
Brazilian Real

• Scott Noble
• Chris Hittesdorf
• Kenji Oka
• Aubrey Gaeta

2
Part 1 Technical Analysis for USD/BRL
Inverted Scale http//fx.sauder.ubc.ca
3
Implications for U.S Hedge Fund

• Close or hedge short positions on USD/BRL
• Open long positions on USD/BRL
• Goal
• Seek to profit off expected short-term weakness
  in the Brazilian Real

4
Conclusions

• Apparent resistance at 2.12
• Projected Real weakness going forward
• Adequate data is available on USD/BRL
• No signal is ever clear or guaranteed
• Right now it is even less clear

5
Part 2 Asset Choice Model

• Decrease in the interest rate over the past 3
  months from 18 to 15.75 putting downward
  pressure on the currency.
• Decreases the demand for the currency
• This country still has one of the highest
  interest rates in the world.
• Inflation rate over the past few years has been
  8.7 which is very high. This could represent an
  area of risk that would decrease the demand for a
  currency that is unstable.

6
Bloomberg Data
7
Balance of Payment Model

• Capital account is running at a surplus of 1.35
  Billion USD
• Trade balance is running deficit of almost 4
  Billion USD
• Upward vs. Downward Pressure
• With a larger trade balance deficit there will be
  more downward pressure on the currency

8
Part 3 Relative PPP Model

• Shows the trend of recent inflation rates.
• The source for estimating the expected annual
  rate of inflation in the US and Brazil.
• Puts weight on each years inflation rate.

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Historical Data (Table 1.)
Inflation Rate (CPI) Inflation Rate (CPI) weight
Year U.S. Brazil
2002 1.59 12.53 5
2003 2.27 9.3 10
2004 2.86 7.6 15
2005 3.39 5.2 25
2006 3.3 4.8 40
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Expected annual rate of inflation 2002-2006

• U.S. 1.59(.05)2.27(.1)2.86(.15)3.39(.25)3.3(.
  4)
• 2.903
• Brazil 12.53(.05)9.3(.1)7.6(.15)5.2(.25)4.8(.
  4)
• 5.9165

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Relative Purchasing Power Parity Model

• The current spot rate of BRL (April 23rd, 2006)
  2.1199
• The expected annual rate of inflation in the
  United States 2.903
• the expected annual rate of inflation in Brazil
  5.9165

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Relative Purchasing Power Parity

• PPP Spot Rate of BRL
• 2.1199 (1.059165)5 / (1.02903)5
• 2.1199 (1.332963 / 1.153826)
• 2.1199 1.15525
• 2.44902

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Result from the relative PPP model

• 5 years into the future, the BRL is forecasted to
  weaken against the dollar.
• Brazilian Real has relatively higher inflation
  rate than the U.S. dollar.
• Therefore, it will experience depreciation on
  foreign exchange markets.

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The implication for the global firm

• The firm selling products in Brazil.
• They will lose their profits in 5 years.
• It takes 2.44902 BRL to convert 1 USD in 5 years.
• It takes 2.1199 BRL to convert 1 USD now.
• The firm manufacturing products in Brazil.
• They will gain their profits in 5 years later.
• They get 2.44902 BRL for 1 USD in 5 years as
  their profits.
• They get only 2.1199 BRL for 1 USD now as their
  profits.

15
Part 4 International Fisher Effect

• European Terms spot rate (4/20/2006) 1 USD BRL
  2.1208
• Brazilian Yield Curve (USD)
• Current Price/Yield 122/5.690
• United States Notes/Bonds
• Current Price/Yield 99-08 ½ /4.920
• Future IFE Spot Rate
• 2.1998 BRL 1 USD

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Analysis of International Fisher Effect

• Future IFE Spot Rate
• 2.1208 x (1.0569)5 2.1998
• (1.0492)5
• So long as interest rates stay the same the Real
  will weaken against the dollar.
• For companies investing overseas, long term
  investments would be good to make if investing in
  manufacturing abroad.
• However, because the inflations rates are higher
  in Brazil than in the US the currency will
  depreciate over the next few years meaning that
  transferring Real back into dollars will not be
  profitable.