International Finance FIE433 Case Study 2 – Parity Relations in International Finance Instructions Students should allocate themselves into Consultancy Teams of around four people (final confirmation of the number in each team to be given after student enrolment). Choose a unique business name for your team. All teams should be prepared to present their results/conclusions to the rest of the class. A printout of the presentation slides should be uploaded on Its Learning and made available to me at the start by ALL teams.
I will then choose randomly the teams to give their presentations of no longer than 20 minutes on the assigned tasks during the tutorials. Emphasis should be put on the presentation of the key points and the overall professionalism of the presentation. Given limited time available, you do not have to answer all questions. Blades plc Case Study Assessment of Potential Arbitrage Opportunities Recall that Blades, a UK manufacturer of roller blades, has chosen Thailand as its primary export target for “Speedos,” Blades’ primary product.
Moreover, Blades’ primary customer in Thailand, Entertainment Products, has committed itself to purchase 180,000 Speedos annually for the next three years at a fixed price denominated in baht, Thailand’s currency. Because of quality and cost considerations, Blades also imports some of the rubber and plastic components needed to manufacture Speedos. Lately, Thailand has experienced weak economic growth and political uncertainty. As investors lost confidence in the Thai baht as a result of the political uncertainty, they withdrew their funds from the country.
This resulted in an excess supply of baht for sale over the demand for baht in the foreign exchange market, which put downward pressure on the baht’s value. As foreign investors continued to withdraw their funds from Thailand, the baht’s value continued to deteriorate. Since Blades has net cash flows in baht resulting from its exports to Thailand, a deterioration in the baht’s value will affect the company negatively. Ben Holt, Blades’ finance director, would like to ensure that the spot and forward rates Blades’ bank has quoted are easonable. If the exchange rate quotes are reasonable, then arbitrage will not be possible. If the quotations are not appropriate, however, arbitrage may be possible. Under these conditions, Holt would like Blades to use some form of arbitrage to take advantage of possible mispricing in the foreign exchange market. Although Blades is not an arbitrageur, Holt believes that arbitrage opportunities could offset the negative impact resulting from the baht’s depreciation, which would otherwise seriously affect Blades’ profit margins.
Ben Holt has identified three arbitrage opportunities as profitable and would like to know which one of them is the most profitable. Thus, he has asked you, Blades’ financial analyst, to prepare an analysis of the arbitrage opportunities he has identified. This would allow Holt to assess the profitability of arbitrage opportunities very quickly. Assumption – transaction costs= 0 1. The first arbitrage opportunity relates to locational arbitrage. Holt has obtained spot rate quotations from two banks in Thailand: Minzu Bank and Sobat Bank, both located in Bangkok.
The bid and ask prices of Thai baht for each bank are displayed in the table below: Minzu BankSobat Bank Bid? 0. 0149? 0. 0152 Ask? 0. 0151? 0. 0153 Determine whether the foreign exchange quotations are appropriate. If they are not appropriate, determine the profit you could generate by withdrawing ? 100,000 from Blades’ checking account and engaging in arbitrage before the rates are adjusted. Exchange quotation are not appropriate. There is a possibility for arbitrage. Potential investor can buy the currency (Thai) in Minzu Bank for 0,0151 and sell it in Sobat Bank for 0,0123 getting ? ,001 profit per every unit. For ? 100 000 we can obtain (100 000/0,0151= 6 622 516,6 Thai in Minzu bank and in next step convert it into ? (6 622 516,6 *0,0152=100 662,3) it in Minzu bank. The profit from arbitrage – 662,3? 2. Besides the bid and ask quotes for the Thai baht provided in the previous question, Minzu Bank has provided the following quotations for the pound and the Japanese yen: Quoted Bid PriceQuoted Ask Price Value of a Japanese yen in British pounds? 0. 0057? 0. 0058 Value of a Thai baht in Japanese yen? 2. 69? 2. 70
Determine whether the cross exchange rate between the Thai baht and Japanese yen is appropriate. If it is not appropriate, determine the profit you could generate for Blades by withdrawing ? 100,000 from Blades’ current account and engaging in triangular arbitrage before the rates are adjusted. Exchange quotation are not appropriate. There is a possibility for arbitrage, because it is possible to buy Thai bath for 0,0151 ? in Minzu ban and sell it by 2,69*0,0057=0,0153 what gives 0,0002? profit per unit. Potential investor convert the currency ? nto :Thai bath in Minzu Bank getting 1000 000/0,0151= 6 622 516,6 Thai bath. Then he/she can convert the money into Yen 6 622 516,6*2,69= 17 814 569,5? and at the end convert it into British pound again 17 814 569,5* 0,0057= 101 543,05 ? The profit from arbitrage – 1543,05 ? 3. Ben Holt has obtained several forward contract quotations for the Thai baht to determine whether covered interest arbitrage may be possible. He was quoted a forward rate of ? 0. 015 per Thai baht for a 90-day forward contract. The current spot rate is ? 0. 0151.
Ninety-day interest rates available to Blades in the United Kingdom are 2 %, while 90-day interest rates in Thailand are 3. 75 % (these rates are not annualized). Holt is aware that covered interest arbitrage, unlike locational and triangular arbitrage, requires an investment of funds. Thus, he would like to be able to estimate the pound profit resulting from arbitrage over and above the pound amount available on a 90-day UK deposit. Determine whether the forward rate is priced appropriately. If it is not priced appropriately, determine the profit you could generate for Blades by withdrawing ? 00,000 from Blades’ current account and engaging in covered interest arbitrage. Measure the profit as the excess amount above what you could generate by investing in the UK money market. Exchange quotation are not appropriate. There is a possibility for arbitrage. We can borrow money from UK for 2,5% (2 plus bank margin) and convert pounds into Thai bath (100 000/0,0151=6 622 516,6 Thai bath to invest in Thailand for 3,75% on 90 day deposit 6 622 516,6 *1,0375= 6870 860,9 Thai bath and hedge risk of exchange rate by forward and sell it for 0,015 ( 6 870 860,9*0,015= 103 062,9 The profit from arbitrage – 3 062,9 ?