Question 1 (20 marks)

In 2011, HSBC Holdings plc (HSBC) cited unfavourable market conditions when shelving plans to list on a proposed Shanghai international board, a move which never came to fruition. However, under the recent Shanghai-London stock connect, firms listed in Shanghai will be able to sell Global Depositary Receipts (GDRs) to investors in London, and those listed in London will be able to issue CDRs to investors in Shanghai. HSBC is set to be the first company to issue CDRs.

Reference: Reuters 2018, HSBC poised to be first firm to issue Chinese Depositary Receipts: sources. Available from: https://www.reuters.com/article/us-hsbc-listing-shanghai/hsbc-poised-to-be-first-firm-to-issue-chinese-depositary-receipts-sources-idUSKCN1MS1KM. Accessed 17 December 2018.

Required:

a.Conduct an arbitrage between HSBC shares listed on the HKSE and those listed on the LSE. Assume the transaction was for 100,000 shares purchased at the closing price on the HKSE on 16 November 2018 and all shares were sold at the opening price on the LSE on 17 December 2018. At what range of spot exchange rates would make the trade profitable?

You are provided with the following information:

16 November 2018 - HKD/GBP spot rate Bid 0.09950 and offer 0.09980

17 December 2018 - HKD/GBP spot rate Bid 0.10140 and offer 0.10170

HK dollar borrowing rate = HIBOR (1 month) 2.30 percent pa + 30 basis points

b.What is the arbitrage gain / loss and at what range of spot exchange rates would make the trade profitable / non-profitable?