Case Study

TopSurf, a U.S. manufacturer of surfing boards has chosen Thailand as its primary export target for Blazing, TopSurf's primary product. Moreover, TopSurf's primary customer in Thailand, Sanuk Ltd, has committed itself to purchase 180,000 Blazing annually for the next 3 years at a fixed price denominated in baht, Thailand's currency. Due to quality and cost considerations, TopSurf also imports some of the rubber and plastic components needed to manufacture Blazing from Thailand.

In recent years, 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. Since TopSurf has net cash flows in baht resulting from its export to Thailand, a deterioration in the baht's value will affect the company negatively.

Amy Miguchi, TopSurf's CFO, would like to ensure that spot and forward rates TopSurf's bank has quoted 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, Miguchi would like TopSurf to use some form of arbitrage to take advantage of possible mispricing in the foreign exchange market. Although TopSurf is not an arbitrageur, Miguchi believes that arbitrage opportunities could offset the negative impact resulting from the baht's depreciation, which would otherwise seriously affect TopSurf's profit margins.

Miguchi has identified three arbitrage opportunities as profitable and would like to know which one of them is the most profitable. Thus, she has asked you, TopSurf's financial analyst, to prepare an analysis of the arbitrage opportunities she has identified. This would allow Miguchi to assess the profitability of arbitrage opportunities quickly.

1. The first arbitrage opportunity relates to locational arbitrage. Miguchi has obtained spot rate quotation from two banks in Thailand: Kasikorn Bank and Siam Bank both located in Bangkok. The bid and ask prices of the Thai baht are displayed in the table below:

Determine whether the foreign exchange quotations are appropriate. If they are not appropriate, determine the profit you could generate by withdrawing $175,000 from TopSurf's checking account and engaging in arbitrage before the rates are adjusted.

2. In addition to the bid and ask quotes for the Thai baht provided in the previous question, Kasikorn Bank has provided the following quotations for the U.S. dollar and the Japanese yen:

Determine whether the cross exchange rate between the Thai baht and Japanese yen is appropriate. If it is not appropriate, determine the profit you could generate for TopSurf by withdrawing $250,000 from TopSurf's checking account and engaging in triangular arbitrage before rates are adjusted.

3. Amy Miguchi has obtained several forward contract quotations for the Thai baht to determine whether covered interest arbitrage may be possible. She was quoted a forward rate of $0.0326 per Thai baht for a 90-day forward contract. The current spot rate is $0.0328.

Ninety-day interest rates available to TopSurf in the U.S. are 0.5 percent, while 90-day interest rate in Thailand are 1.0 percent (these rates are not annualized).

Miguchi is aware that covered interest arbitrage, unlike locational and triangular arbitrage, required an investment of funds. Thus, she 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 TopSurf by withdrawing $200,000 from TopSurf's checking account 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.

Instructions:

Each question is worth 5% for a total of 15% for this case study

• Answer each question by typing the answers in a Word document sequentially.
• For each question, show clearly all the steps involved in the arbitrage transactions.
• Do not give just the final answer, you will receive zero even if that answer is correct. I need to see the steps involved in each calculation to ensure that you have understood the material.
• You will receive partial credit, even if the final answer is incorrect, as long as the steps are correct.