BLADES, INC. CASE Assessment of Potential Arbitrage Opportunities

Recall that Blades, a U.S. 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 annu- ally 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 from Thailand. 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 coun- try. This resulted in an excess supply of baht for sale over the demand for baht in the foreign exchange mar- ket, 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 deterio- rate. Because Blades has net cash flows in baht resulting from its exports to Thailand, any deterioration in the baht's value will affect the company negatively. Ben Holt, Blades' CFO, would like to ensure that the spot and forward rates quoted by Blades' bank are reasonable. 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 result- ing from the baht's depreciation, which would otherwise seriously affect Blades' profit margins. Holt has identified three arbitrage opportunities a profitable and would like to know which one of them is the most profitable. He has asked you, Blades' financial analyst, to prepare an analysis of the arbitrage opportu- nities he has identified. This would allow Holt to assess the profitability of arbitrage opportunities very quickly. quota-

1. The first arbitrage opportunity relates to loca- tional arbitrage. Holt has obtained spot rate tions 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 following table: Bid Ask MINZU BANK $0.0224 $0.0227 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 arbi- trage before the rates are adjusted. SOBAT BANK $0.0228 $0.0229 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: Value of a Japanese yen in U.S. dollars Value of a Thai baht in Japanese yen QUOTED BID PRICE $0.0085 2.69 QUOTED ASK PRICE $0.0086 2.70

Assessment of Potential Arbitrage Recall that Blades, a U.S, 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 from Thailand. 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. Because Blades has net cash flows in baht resulting from its exports to Thailand, any deterioration in the baht's value will affect the company negatively, Ben Holt, Blades' CFO, would like to ensure that the spot and forward rates quoted by Blades' bank are reasonable. 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. Holt has identified three arbitrage opportunities at profitable and would like to know which one of them is the most profitable. He has asked you, Blades' finatichal analyst, to prepare an analysis of the arbitrage opporty nities he has identified. This would allow Holt to amey the profitability of arbitrage opportunities very quicky 1. The first arbitrage opportunity relates to locational arbitrage. Holt has obtained spot rate quota. tions 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 following table: 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 arb. trage before the rates are adjusted. 2. Besides the bid and ask quotes for the Thai bahy provided in the previous question, Minzu Bank has provided the following quotations for the U.S. dollar and the lapanese yen