Blades, Inc.

Case

Assessment of Potential Arbitrage Opportunities

Arranged by: Hilmiyah Amaliyati 108081100009

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, Thailands 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

Answer Q1
Minzu Bank
Bid Ask $ 0.0224 $ 0.0227

Sobat Bank
$ 0.0228 $ 0.0229

Locational Arbitrage $ 100,000 1) Buy Thai baht from Minzu Bank 1 THB $ 0.0227 X $ 100,000 X= $ 100,000 $ 0.0227 = THB 4,405,286.34

2) Sell Thai baht to Sobat Bank 1 THB $ 0.0228 THB 4,405,286.34 x X = THB 4,405,286.34 $ 0.0228 = 3) Dollar profit Final amount Initial amount $ 100,440.53

$ 100,440.53 $ 100,000 Total Profit

$440.53

Answer Q2
Quoted Bid Price Quoted Ask Price Value of a Japanese $0.0085 $0.0086 yen in U.S. dollars Value of a Thai baht in 2.69 2.70 Japanese yen Triangular Arbitrage From $ 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

2) Convert THB 1 THB THB 4,405,286.34

2.69 x 11,850,220.25

X = THB 4,405,286.34 2.69 = 3) Convert $ 1 11,850,220.25

$0.0085 x $ 100,726.87

X = 11,850,220.25 $0.0085 =

4) Dollar profit Final amount Initial amount Total Profit

$ 100,726.87 $ 100,000
$ 726.87

Answer Q3
Covered Interest Arbitrage $ 100,000 to deposit The current spot rate $ 0.0227 The 90-days forward rate $ 0.0225 The 90-days interest rate $ 2 percent The 90-days interest rate THB 3.75 percent 1) Converting $ 1 THB X X= THB $ 0.0227 $ 100,000 $ 100,000 $ 0.0227 THB 4,405,286.34

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 THB 4,570,484.58

$ $ 0.0225 X
$ 102,835.90

X = THB 4,570,484.58 $ 0.0225 =

4) Dollar profit Final amount Initial amount

$ 102,835.90 $ 100,000
$ 2,835.90

Total Profit

Answer Q4
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.