Question

2. Explain how the Asian crisis would have affected the returns to a European firm investing in the Asian stock markets as a means of international diversification. Illustrate with suitable example.

Answer 1

What Was the Asian Financial Crisis?

The Asian financial crisis, also called the "Asian Contagion," was a sequence of currency devaluations and other events that began in the summer of 1997 and spread through many Asian markets. The currency markets first failed in Thailand as the result of the government's decision to no longer peg the local currency to the U.S. dollar (USD). Currency declines spread rapidly throughout East Asia, in turn causing stock market declines, reduced import revenues, and government upheaval.

Understanding the Asian Financial Crisis

As a result of the devaluation of Thailand's baht, a large portion of East Asian currencies fell by as much as 38 percent. International stocks also declined as much as 60 percent. Luckily, the Asian financial crisis was stemmed somewhat due to financial intervention from the International Monetary Fund and the World Bank. However, the market declines were also felt in the United States, Europe, and Russia as the Asian economies slumped.

Modern Case of the Asian Financial Crisis affecting European firm-

The world markets have fluctuated greatly over the past two years, from the beginning of 2015 through the second quarter of 2016. This caused the Bank of England to fear the possibility of a second Asian financial crisis. For example, China sent a shockwave through equity markets in the England on August 11, 2015, when it devalued the yuan against the EURO. This caused the Chinese economy to slow, resulting in lower domestic interest rates and a large amount of bond float.

The low interest rates enacted by China encouraged other Asian countries to decrease their domestic interest rates. Japan, for example, cut its already-low short-term interest rates into the negative numbers in early 2016. This prolonged period of low interest rates forced Japan to borrow increasingly larger sums of money to invest in global equities markets. The Japanese yen responded counterintuitively by increasing in value, making Japanese products more expensive and further weakening its economy.

The Europe equity markets responded with a drop of 11.5 percent from January 1 to February 11, 2016. Though the markets subsequently rebounded by 13 percent in the following year, volatility followed throughout the rest of 2016 until the effects of this situation had fully dissipated.