Country's Best Services, (CBS, Inc.), a US based company, will receive 2,610,000 Canadian dollars in three months for the services rendered to a Canadian corporation. The current exchango-rate on May 16, 1995 was 1USS=C$1.3594. The CEO of CBS, Mr. Safeguard was concemed that the Canadian dollar might depreciate against the US$ during the next 90 days --before or at the time of the payment made by the Canadian corporation. Mr. Safeguard had called his account manager at the bank, Judy Edge, to ask for her advice regarding various alternatives to hedge the foreign currency risk. Ms. Edge, after evaluating macroeconomic fundamentals and determining what her bank's lending rates were likely to be based on this outlook, was now ready to advise Mr. Safeguard of the various alternatives to hedge the foreign currency risk. She prepared the following list of altematives for Mr. Safeguard. Your task is to analyzc'evaluate cach of the three hedging alternatives available for CBS. Specifically, you need to calculate total $US proceeds three months from May 16h under cach alternative. 4. Forward contract: As of May 16", the bank quoted the three-month forward rate as 1USS-CS1.3653. b. Foreign currency option: At the time, the 90-day currency put-option premium written on Canadian dollar with a strike of ICS=USS.7200 was: put premium=USS 0.0225 per C$. c. Money Market Hedge (or Foreign Currency Loan): As an altemative Ms. Edge was ready to offer a Canadian dollar loan to CBS at 2.25% above the present Canadian prime rate of 10.25% with a zero arrangement fee due to their long-term relationships. She explained to Mr. Safeguard that he could borrow in Canadian dollars against the Canadian dollars to be received in 3 months and convert immediately into US dollars. This way, she suggested CBS would eliminate any exchange rate risk associated with the transaction. At the time of this conversation, the US interest rate was around 11%. II. In addition to Canada, CBS also provides services to customers in Thailand. Mr. Safeguard, therefore, closely follows the current economic conditions and exchange rate quotes in this country both for hedging purposes and arbitrage opportunities. Based on current market information, he has identified three possible arbitrage opportunities associated with foreign currency transactions and would like to know which one is the most profitable: a. The first arbitrage opportunity relates to locational arbitrage. Safeguard has obtained spot rate quotations from two banks in Thailand, Minzu Bank and Sobat Batik, both located in Banekok. The bid and ask prices of Thai baht for each bank are displayed in the table below: Bid Ask Minzu Bank S0.0224 S0.0227 Sobat Bank $0.0228 10.0229 Determine whether the foreign exchange quotations are appropriate. If they are not, determine the profit Mr. Safeguard could generate by using $100,000 and engaging in arbitrage before the rates are adjusted. b. Mr. Safeguard has obtained several forward contract quotations for the Thai baht to determine whether covered interest arbitrage ray be possible. IIe was quoted a forward rate of So.0225 per Thai baht for a 90-day forward contract. The current spot rate is $0.0227. Ninety-day interest rates available to CBS in the U.S. 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, determine the profit you could generate for CBS by using $100,000 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. c. Assume that besides the two potential arbitrage opportunities listed above, Mr. Safeguard is exposed to following exchange rates (ignoring transaction costs, i.e. bid-ask spreads) quoted by Sonzu Bank among three currencies: US dollar, Japanese Yen, and Thai Baht. Determine whether the cross exchange rate between the Thai baht and Japanese yen based on Sonzu Bank quotations is appropriate. If it is not appropriate, determine the profit you could generate for CBS by using S100,000 and engaging in triangular arbitruge before the rates are adjusted. Sonzu Bank Quotations S(STB) S(S/JY) S(JY/TB) $0.01227 $0.008S 42.6900 Country's Best Services, (CBS, Inc.), a US based company, will receive 2,610,000 Canadian dollars in three months for the services rendered to a Canadian corporation. The current exchango-rate on May 16, 1995 was 1USS=C$1.3594. The CEO of CBS, Mr. Safeguard was concemed that the Canadian dollar might depreciate against the US$ during the next 90 days --before or at the time of the payment made by the Canadian corporation. Mr. Safeguard had called his account manager at the bank, Judy Edge, to ask for her advice regarding various alternatives to hedge the foreign currency risk. Ms. Edge, after evaluating macroeconomic fundamentals and determining what her bank's lending rates were likely to be based on this outlook, was now ready to advise Mr. Safeguard of the various alternatives to hedge the foreign currency risk. She prepared the following list of altematives for Mr. Safeguard. Your task is to analyzc'evaluate cach of the three hedging alternatives available for CBS. Specifically, you need to calculate total $US proceeds three months from May 16h under cach alternative. 4. Forward contract: As of May 16", the bank quoted the three-month forward rate as 1USS-CS1.3653. b. Foreign currency option: At the time, the 90-day currency put-option premium written on Canadian dollar with a strike of ICS=USS.7200 was: put premium=USS 0.0225 per C$. c. Money Market Hedge (or Foreign Currency Loan): As an altemative Ms. Edge was ready to offer a Canadian dollar loan to CBS at 2.25% above the present Canadian prime rate of 10.25% with a zero arrangement fee due to their long-term relationships. She explained to Mr. Safeguard that he could borrow in Canadian dollars against the Canadian dollars to be received in 3 months and convert immediately into US dollars. This way, she suggested CBS would eliminate any exchange rate risk associated with the transaction. At the time of this conversation, the US interest rate was around 11%. II. In addition to Canada, CBS also provides services to customers in Thailand. Mr. Safeguard, therefore, closely follows the current economic conditions and exchange rate quotes in this country both for hedging purposes and arbitrage opportunities. Based on current market information, he has identified three possible arbitrage opportunities associated with foreign currency transactions and would like to know which one is the most profitable: a. The first arbitrage opportunity relates to locational arbitrage. Safeguard has obtained spot rate quotations from two banks in Thailand, Minzu Bank and Sobat Batik, both located in Banekok. The bid and ask prices of Thai baht for each bank are displayed in the table below: Bid Ask Minzu Bank S0.0224 S0.0227 Sobat Bank $0.0228 10.0229 Determine whether the foreign exchange quotations are appropriate. If they are not, determine the profit Mr. Safeguard could generate by using $100,000 and engaging in arbitrage before the rates are adjusted. b. Mr. Safeguard has obtained several forward contract quotations for the Thai baht to determine whether covered interest arbitrage ray be possible. IIe was quoted a forward rate of So.0225 per Thai baht for a 90-day forward contract. The current spot rate is $0.0227. Ninety-day interest rates available to CBS in the U.S. 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, determine the profit you could generate for CBS by using $100,000 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. c. Assume that besides the two potential arbitrage opportunities listed above, Mr. Safeguard is exposed to following exchange rates (ignoring transaction costs, i.e. bid-ask spreads) quoted by Sonzu Bank among three currencies: US dollar, Japanese Yen, and Thai Baht. Determine whether the cross exchange rate between the Thai baht and Japanese yen based on Sonzu Bank quotations is appropriate. If it is not appropriate, determine the profit you could generate for CBS by using S100,000 and engaging in triangular arbitruge before the rates are adjusted. Sonzu Bank Quotations S(STB) S(S/JY) S(JY/TB) $0.01227 $0.008S 42.6900