BWFF$5043$ INTERNATIONAL FINANCIAL MANAGEMENT

DC$232$

ASSIGNMENT

PART A

Kedah Rubber Sdn Bhd $($KR$),$ established in $2000$ and headquartered in Sungai Petani, Kedah,

is the manufacturer of rubber gloves. Recently, it has decided to expand its business to export

its products to the United Kingdom $($UK$).$ Bath, Ltd$.,$ a British retailer, has committed to

purchase $1,000,000$ pair of gloves annually for a price of $1\mathrm{.}00$ per pair. According to the

agreement, KR is to sell the gloves to Bath for $2$ years. Sales are to be made quarterly; $250,000$

pair of gloves for each quarter. First sale will occur one quarter from now. Payment for the

sales is to made on the first day of January, April, July and October.

Lately, UK has experienced weak economic growth and political uncertainty. Investors

withdrew their fund from the country as they lost confidence in the British pound as a result of

the political uncertainty. This resulted in an excess supply of British pound for sale over the

demand for British pound in the foreign exchange market, which put downward pressure on

the British pound$$s value. For the past few weeks, the British pound continued to deteriorate.

KR is concerned with the situation as a deterioration in the British pound$$s value will affect the

company negatively.

Mr$.$ Azman, KR$$s chief financial officer $($CFO$),$ would like to determine whether arbitrage is

possible. If the spot and forward rates are not reasonably quoted, then arbitrage will be possible.

Mr$.$ Azman would like to use some of arbitrage to offset the negative impact resulting from the

British pound$$s depreciation. Mr$.$ Azman has managed to obtain the following information:

Value of a British pound in ringgit RM$5\mathrm{.}99/$

Value of a U$.$S$.$ dollar in ringgit RM$4\mathrm{.}72/$$

Value of a British pound in U$.$S$.$ dollars $$1\mathrm{.}25/$

$90-$day forward rate RM$5\mathrm{.}93/$

$90-$day interest rate $$ United Kingdom $3\mathrm{.}75\%$

$90-$day interest rate $$ Malaysia $2\%$

REQUIRED:

$1.$ Determine whether the cross$-$exchange rate between the British pound and the U$.$S$.$ dollar

is appropriate. If it is not appropriate, determine the profit Mr$.$ Azman could generate for

KR$,$ by withdrawing RM$100,000$ from KR$$s checking account and engaging in triangular

arbitrage.

$2.$ Determine whether the forward rate is priced appropriately. If it is not priced

appropriately, determine the profit En$.$ Azman could generate for KR by withdrawing

RM$100,000$ from KR$$s checking account and engaging in covered interest arbitrage.

Measure the profit as the excess amount above what En$.$ Azman could generate by

investing in the Malaysian money market