Cherry Blink is a company located in Geneva, Switzerland. The company manufacturing high end jewellery for men and women. Cherry Blink's main customer, Sehr Schon, a Hong Kong company has entered a contract to purchase the jewelry with an annual amount of HKD 25,000,000 for the next 3 years. Lately, Hong Kong has experienced weak economic growth and political instability due to Anti-Extradition Law Amendment Bill Movement. Hence, foreign investors lost confidence in the Hong Kong Dollar (HKD) and withdrawn their investment from Hong Kong which resulted in excess supply of HKD for sale over the demand of HKD in the foreign market, that caused downward pressure on HKD.

There are huge tendencies that HKD value will continue to deteriorate. The HKD's reducing value can give negative effect to Cherry Blink due to net cash flow resulted from its export to Sehr Schon. The finance department of Cherry Blink would like to ensure that the spot and forward rates that their bank offered are reasonable. If the quotes are reasonable, then no arbitrage can be carried out. Arbitrage is only possible when the spot and forward rates are not appropriate.

The head of finance department, Mr. Hertz would like the Cherry Blink to take advantage of any currency mispricing by doing arbitrage with hope that the arbitrage profit can offset any negative impact on Cherry Blink's profit margin due to HKD depreciation. Mr. Hertz has identified few arbitrage opportunities which are profitable.

Since you are just appointed as financial analyst of Cherry Blink, Mr. Hertz is instructing you to prepare an analysis for arbitrage opportunities.

1. The quotation of CHF/HKD are available in the table below. (a) Determine whether the quotations given are appropriate. Prove your answer. (b) If the quotations are not appropriate, find the profit that you can make from the locational arbitrage. Assume that you have CHF5,000,000.

Bid Ask

Bank A (CFH/HKD) 0.1165 0.1168

Bank B (CFH/HKD) 0.1161 0.1162

2. Three different banks have sent their special quotation to Mr Hertz. Based on the quotation given below, Mr Hertz instructed you to determine the triangular arbitrage profit for Cherry Blink if you are given CHF5,000,000.

Bid Ask

Bank X CHF 0.9855/USD CHF 0.9858/USD

Bank Y CHF 0.117/HKD CHF0.1174/HKD

Bank Z USD 0.1279/HKD USD 0.1283/HKD

3. Another possible step to reduce the impact of reducing value of HKD towards Cherry Blink is to consider covered interest arbitrage. The forward contract for a 180-day on HKD is CHF0.1150 and the current spot rate is CHF 0.1155/HKD. The 180-day interest rate available to Cherry Blink in Switzerland is 3% per annum, whilst in Hong Kong the 180-day interest rate is 5% per annum. (a) Which country should Cherry Blink borrow and invest if the Cherry Blink intends to get profit form covered interest arbitrage? (b) Determine the amount of profit from this covered interest arbitrage if you are going to use CHF5,000,000 or HKD in equivalent.

4. What action should the Hong Kong Monetary Authority (which is acting as Central Bank for Hong Kong) implement to stop the further changes of its currency value?