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Arbitrage Anaylsis Essay

932 words - 4 pages

Arbitrage Analysis

After reviewing Putnam, Inc’s situation with the currency depreciation of the Thai Baht, it has become clear that indeed there are three different forms of arbitrage possible to exploit the situation and turn a profit. These forms of arbitrage are locational, triangular, and covered interest. While it would be great to try them all, we understand it is only feasible to do the most profitable. This analysis will review all three forms of arbitrage and determine which form will be the most profitable.
Locational arbitrage is possible when one banks Ask price is lower than another banks Bid price. When this happens, an individual can purchase the currency at ...view middle of the document...

S. dollar and the Japanese Yen is 1 U.S. dollar to .0084 yen. So, you convert the $100,000 to Yen. To do this, you take 100,000 and divide is by .0084 which gives you 11,904,761.9 Yen. The exchange rate between the Japanese Yen and the Thai Baht is 1 Japanese Yen equals 2.69 Thai Bahts. You then convert the Yen into Bahts by taking 11,904,761.9 and dividing that by 2.69, which gives you 4,425,562.05 Thai Bahts. Then to complete the triangular arbitrage you have to convert the Thai Baht to the original currency, which in this case, is the U.S. dollar. The exchange rate between the Thai Baht and the U.S. dollar is 1 Thai Baht equals .023 U.S. dollars. So you convert the Thai Baht into dollars by taking 4,425,562.05 and multiply it by .023 which gives you $102,673.04. To find the total profit you take the ending balance and subtract the original investment of $100,000. This will leave Putnam Inc. with a $2673.04 profit. What makes this opportunity possible is the Thai Baht is valued at more than it should be in terms of the Japanese Yen. The value of the Baht with respect to the U.S. dollar would rise. The value of the Baht with respect to the Yen would decline. Then, the value of the Thai Baht to the U.S. dollar would fall.
Covered Interest arbitrage is plausible when the forward premium does not reflect the interest rate differential between two countries specified by the interest rate parity formula. If transactions costs or other considerations are involved, the excess profit from covered interest arbitrage must more than offset these other considerations for covered interest arbitrage to be...

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