Question

You are the CFO of a US manufacturer that exports to Thailand. You have received spot rate quotations from two banks in Thailand, Minzu Bank and Sobat Bank, both located in Bangkok. The bid and ask prices of Thai baht for each bank are displayed in the table below:

Minzu Bank (THB/$)         Sobat Bank (THB/$)

Bid $0.0224                          $0.0228

Ask $0.0227                         $0.0229

a) Are these direct quotes or indirect quotes for the US manufacturer? Are they quoted in European or American terms?

b) Determine whether there is an arbitrage opportunity. If there is, determine the profit you could generate by withdrawing $100,000 from the company's chequing account and engaging in arbitrage before the rates are adjusted.

Answer 1

Given that US manufacturer is exporting to Thailand. Thailand banks provided quotes to US manufacturer.

a) When domestic currency is expressed with respect to one unit of foreign currency, it is called direct quote. In indirect quote, foreign currency is expressed with respect to one unit of domestic currency. Given quotes are as follows

Minzu Bank (THB/$)         Sobat Bank (THB/$)

Bid $0.0224                        Bid $0.0228

Ask $0.0227                        Ask $0.0229

Here quotes are in dollars for every 1 THB. Hence it is indirect quote.

b) There is an arbitrage opportunity because Bid and Ask rates offered by both the banks are different. So if we withdraw $100,000 from company's checking account and convert it to THB from bank which has lowest ask rate i.e, Minzu Bank.

We get THB 4,405,286.344 for $ 100,000 from Minzu Bank. (100000/0.0227 = 4,405,286.344)

Convert this THB to dollars from bank which is paying highest bid rate i.e, Sobat Bank

We get $ 100,440.53 in return for THB 4,405,286.344 from Sobat Bank. ( 4,405,286.344 * 0.0228 = 100,440.53)

Profit from arbitrage transaction is $ 440.53