A UK power station relies on imported coal as an input. A Chinese coal mine can supply coal for RMB266 per ton from the docks at Tianjin, while a Polish supplier is offering the same grade of coal from the docks at Gdansk (Poland) for 30.00 per ton. The power station reckons that transporting a ton of coal from Tianjin to the UK will cost it $5.00, but from Gdansk only $3.00.

(a) If the exchange rates are currently 1.00 = $1.88 = 1.47 (floating), while the Chinese exchange rate is fixed at $1.00 = RMB8.3, should the UK power station buy coal from China or Poland? If it buys from wherever is cheapest, how much does it pay in sterling?

(b) How would your answer change if the dollar appreciated to 1.00 = $1.60, while everything else remained unchanged?

(c) With the situation as in Part (a) above, suppose the UK buyer is worrying how its costs would be affected by a possible Chinese revaluation of the RMB, which is rumoured to be currently under consideration in Beijing. By how much would the RMB need to be revalued against the dollar to make the UK buyer indifferent between the two sources?

(d) With the situation as in Part (a) above, if the UK company calculates it can shift a ton of coal from the Chinese to the Polish port at a shipping cost of $4.00, is there an opportunity for it to engage in a little profitable arbitrage? If so, how much profit could it make?