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 $.0225 per Thai baht for a90-day forward contract. The current spot rate is$.0227. Ninety-day interest rates available to Blades in the United States are 2 percent, while 90-day interest rates in Thailand are 3.75 percent (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 dollar profit resulting from arbitrage over and above the dollar amount available on a 90-day U.S. deposit.

Determine whether the forward rate is priced appropriately. If it is not priced appropriately, deter-mine the profit you could generate for Blades by withdrawing $100,000 from Blades checking account and engaging in covered interest arbitrage. Measure the profit as the excess amount above what you could generate by investing in the U.S. money market. Why are arbitrage opportunities likely to disappear soon after they have been discovered? To illustrate your answer, assume that covered interest arbitrage involving the immediate purchase and forward sale of baht is possible. Discuss how the bahts spot and forward rates would adjust until covered interest arbitrage is no longer possible. What is the resulting equilibrium state called?

BLADES, Inc. CASE Assessment of Potential Arbitrage Opportunities Recall that Blades, a U.S. manufacturer of roller blades, As foreign investors continued to withdraw their funds has chosen Thailand as its primary export target for from Thailand, the baht's value continued to deterio- Speedos, Blades' primary product. Moreover, Blades' rate. Since Blades has net cash flows in baht resulting primary customer in Thailand, Entertainment from its exports to Thailand, a deterioration in the Products, has committed itself to purchase 180,000 baht's value will affect the company negatively. Speedos annually for the next 3 years at a fixed price Ben Holt, Blades' CFO, would like to ensure that the denominated in baht, Thailand's currency. Because of spot and forward rates Blades' bank has quoted are quality and cost considerations, Blades also imports reasonable. If the exchange rate quotes are reasonable, some of the rubber and plastic components needed to then arbitrage will not be possible. If the quotations are manufacture Speedos from Thailand. not appropriate, however, arbitrage may be possible. Lately, Thailand has experienced weak economic Under these conditions, Holt would like Blades to use growth and political uncertainty. As investors lost con some form of arbitrage to take advantage of possible fidence in the Thai baht as a result of the political mispricing in the foreign exchange market. Although uncertainty, they withdrew their funds from the coun Blades is not an arbitrageur, Holt believes that arbitrage try. This resulted in an excess supply of baht for sale opportunities could offset the negative impact resulting over the demand for baht in the foreign exchange mar from the baht's depreciation, which would otherwise ket, which put downward pressure on the baht's value. seriously affect Blades' profit margins. 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. 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 BANK SOBAT BANK Bid $.0224 $.0228 Ask $.0227 $.0229 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 gen- erate for Blades by withdrawing $100,000 from Blades' checking account and engaging in triangular arbitrage before the rates are adjusted. 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 $.0225 per Thai baht for a 90-day forward contract. The current spot rate is $.0227. Ninety-day interest rates available to Blades in the United States are 2 percent, while 90-day interest rates in Thailand are 3.75 percent (these rates are not annualized). Holt is aware that covered interest arbi- trage, unlike locational and triangular arbitrage, requires an investment of funds. Thus, he would like to be able to estimate the dollar profit resulting from arbitrage over and above the dollar amount available on a 90-day U.S. deposit. Determine whether the forward rate is priced appropriately. If it is not priced appropriately, deter- mine the profit you could generate for Blades by withdrawing $100,000 from Blades' checking account and engaging in covered interest arbitrage. Measure the profit as the excess amount above what you could generate by investing in the U.S. money market. 4. Why are arbitrage opportunities likely to disappear soon after they have been discovered? To illustrate your answer, assume that covered interest arbitrage involv- ing the immediate purchase and forward sale of baht is possible. Discuss how the baht's spot and forward rates would adjust until covered interest arbitrage is no longer possible. What is the resulting equilibrium state called? 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. 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 U.S. dollar and the Japanese yen: QUOTED BID PRICE QUOTED ASK PRICE $.0085 $.0086 Value of a Japanese yen in U.S. dollars Value of a Thai baht in Japanese yen 2.69 2.70 BLADES, Inc. CASE Assessment of Potential Arbitrage Opportunities Recall that Blades, a U.S. manufacturer of roller blades, As foreign investors continued to withdraw their funds has chosen Thailand as its primary export target for from Thailand, the baht's value continued to deterio- Speedos, Blades' primary product. Moreover, Blades' rate. Since Blades has net cash flows in baht resulting primary customer in Thailand, Entertainment from its exports to Thailand, a deterioration in the Products, has committed itself to purchase 180,000 baht's value will affect the company negatively. Speedos annually for the next 3 years at a fixed price Ben Holt, Blades' CFO, would like to ensure that the denominated in baht, Thailand's currency. Because of spot and forward rates Blades' bank has quoted are quality and cost considerations, Blades also imports reasonable. If the exchange rate quotes are reasonable, some of the rubber and plastic components needed to then arbitrage will not be possible. If the quotations are manufacture Speedos from Thailand. not appropriate, however, arbitrage may be possible. Lately, Thailand has experienced weak economic Under these conditions, Holt would like Blades to use growth and political uncertainty. As investors lost con some form of arbitrage to take advantage of possible fidence in the Thai baht as a result of the political mispricing in the foreign exchange market. Although uncertainty, they withdrew their funds from the coun Blades is not an arbitrageur, Holt believes that arbitrage try. This resulted in an excess supply of baht for sale opportunities could offset the negative impact resulting over the demand for baht in the foreign exchange mar from the baht's depreciation, which would otherwise ket, which put downward pressure on the baht's value. seriously affect Blades' profit margins. 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. 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 BANK SOBAT BANK Bid $.0224 $.0228 Ask $.0227 $.0229 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 gen- erate for Blades by withdrawing $100,000 from Blades' checking account and engaging in triangular arbitrage before the rates are adjusted. 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 $.0225 per Thai baht for a 90-day forward contract. The current spot rate is $.0227. Ninety-day interest rates available to Blades in the United States are 2 percent, while 90-day interest rates in Thailand are 3.75 percent (these rates are not annualized). Holt is aware that covered interest arbi- trage, unlike locational and triangular arbitrage, requires an investment of funds. Thus, he would like to be able to estimate the dollar profit resulting from arbitrage over and above the dollar amount available on a 90-day U.S. deposit. Determine whether the forward rate is priced appropriately. If it is not priced appropriately, deter- mine the profit you could generate for Blades by withdrawing $100,000 from Blades' checking account and engaging in covered interest arbitrage. Measure the profit as the excess amount above what you could generate by investing in the U.S. money market. 4. Why are arbitrage opportunities likely to disappear soon after they have been discovered? To illustrate your answer, assume that covered interest arbitrage involv- ing the immediate purchase and forward sale of baht is possible. Discuss how the baht's spot and forward rates would adjust until covered interest arbitrage is no longer possible. What is the resulting equilibrium state called? 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. 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 U.S. dollar and the Japanese yen: QUOTED BID PRICE QUOTED ASK PRICE $.0085 $.0086 Value of a Japanese yen in U.S. dollars Value of a Thai baht in Japanese yen 2.69 2.70