Arranged by:Hilmiyah Amaliyati

108081100009

Blades, Inc. Case

Assessment of Potential Arbitrage Opportunities

Introduction

Recall that Blades, a U.S. manufacturer of roller blades, has chosen Thailand as its primary export target for Speedos, Blades’ primary product.

Blades’ primary customer in Thailand, Entertainment Products, has committed itself to purchase 180,000 Speedos annually for the next 3 years at a fixed price denominated in bath, Thailand’s currency.

Because of quality and cost considerations, Blades also imports some of the rubber and plastic components needed to manufacture Speedos from Thailand.

Thailand has experienced weak economic growth and political uncertainty. As investors lost confidence in the Thai bath as a result of the political uncertainty, they withdraw their funds from the country.

Ben Holt, Blades’ CFO, would like to ensure that the spot and forward rates Blades’ bank has quoted are reasonable.

Ben Holt has identified three arbitrage opportunities as profitable and would like to know which one of them is the most profitable.

DISCUSSION QUESTIONS

  Minzu Bank Sobat Bank

Bid $ 0.0224 $ 0.0228

Ask $ 0.0227 $ 0.0229

Locational Arbitrage$ 100,0001) Buy Thai baht from Minzu Bank

1 THB $ 0.0227 X $ 100,000 

X = $ 100,000

$ 0.0227 = THB 4,405,286.34

Answer Q1

2) Sell Thai baht to Sobat Bank1 THB $ 0.0228THB 4,405,286.34 x

 X = THB 4,405,286.34 × $ 0.0228 = $ 100,440.53 3) Dollar profit

Final amount $ 100,440.53Initial amount $ 100,000

Total Profit$440.53

  Quoted Bid Price

Quoted Ask Price

Value of a Japanese yen in U.S. dollars

$0.0085 $0.0086

Value of a Thai baht in Japanese yen

¥2.69 ¥2.70

Triangular ArbitrageFrom $ changed to Thai Bath (THB) changed to Japanese Yen (¥) changed to $1) Exchange $ THB

1 THB $ 0.0227 X $ 100,000 

X = $ 100,000 = THB 4,405,286.34

$ 0.0227

Answer Q2

2) Convert THB ¥1 THB ¥ 2.69THB 4,405,286.34 x

X = THB 4,405,286.34 × ¥ 2.69 = ¥ 11,850,220.25

3) Convert ¥ $1 ¥ $0.0085¥ 11,850,220.25 x

X = ¥ 11,850,220.25 × $0.0085 = $ 100,726.87

4) Dollar profitFinal amount $ 100,726.87Initial amount $ 100,000

Total Profit $ 726.87

Covered Interest Arbitrage$ 100,000 to depositThe current spot rate $ 0.0227The 90-days forward rate $ 0.0225The 90-days interest rate $ 2 percentThe 90-days interest rate THB 3.75 percent

 1) Converting $ THB

1 THB $ 0.0227 X $ 100,000

X = $ 100,000

$ 0.0227 THB 4,405,286.34

Answer Q3

2) In 90 days, the Thai deposit will mature to Initial 1 THB $ 0.0225 THB 4,405,286.34 Interest THB 3.75 % × THB 4,405,286.34 = THB 165,196.2378

Final/total THB 4,570,484.58

3) In 90 days, convert THB $90 days 1 THB $ 0.0225THB 4,570,484.58 X

X = THB 4,570,484.58 × $ 0.0225 = $ 102,835.90

4) Dollar profitFinal amount $ 102,835.90Initial amount $ 100,000

 Total Profit $

2,835.90

Arbitrage opportunities are likely to disappear soon after they have been discovered because of market forces.Due to the actions taken by arbitrageurs, supply and demand for the foreign currency adjust until the mispricing disappears. For example, covered interest arbitrage involving the immediate purchase and subsequent sale of Thai baht would place upward pressure on the spot rate of the Thai baht and downward pressure on the Thai baht forward rate until covered interest arbitrage is no longer possible. At that point, interest rate parity exists, and the interest rate differential between the two countries is exactly offset by the forward premium or discount.

Answer Q4