INTERNATIONAL FINANCIAL MANAGEMENT
STUDENT NUMBER
MODULE CODE
UNIQUE ASSIGNMENT NUMBER
FULL NAME
Gainmore Gutsa (51968932)
FIN4802: ASSIGNMENT 1
51968932
FIN4802
647338
GAINMORE GUTSA
Unique Assignment # 647338
INTERNATIONAL FINANCIAL MANAGEMENT
FIN4802: ASSIGNMENT 1
QUESTION 1
(a) Locational arbitrage is possible.
Bid
Ask
Step 1
Step 2
Step 3
Maybank
R3.149
R3.151
RHB Bank
R3.152
R3.153
Bank buys Malaysian ringgit at this price
Bank sells Malaysian ringgit at this price
Buy the Malaysian ringgit from Maybank @ R3.151
(R1 000 000/R3.151)
Sell Malaysian ringgit to RHB Bank @ R3.152
(MYR317 360 * R3.152)
Rand profit calculation
(R1 000 319 - R1 000 000)
MYR317 360
R1 000 319
R319
(b) Triangular arbitrage is possible.
Value of Japanese Yen in South African Rand
Value of Malaysian Ringgit in Japanese Yen
Step 1
Step 2
Step 3
Step 4
Quoted bid price
R0.1057
¥32.69
Exchange Rand for Malaysian Ringgit
(R1 000 000/R3.151)
Convert Malaysian Ringgit into Japanese Yen
(MYR317 360 * ¥32.69)
Convert Japanese Yen to Rand
(¥10 374 498 * R0.1058)
Rand profit calculation
(R1 097 622 - R1 000 000)
Quoted ask price
R0.1058
¥32.70
MYR317 360
¥10 374 498
R1 097 622
R97 622
(c) Covered interest arbitrage is possible and forward rate is not priced appropriately.
Step 1
Step 2
Step 3
Step 4
Step 5
Day 1 – convert rands to Malaysian ringgit and set up a 90day deposit account at a Malaysian bank
(R1 000 000/R3.151)
In 90 days the Malaysian ringgit will mature and be sold
forward
(MYR317 360 * 1.0375)
In 90 days convert MYR329 261 to rands at rate of R3.150
(MYR329 261 * R3.150)
Rand amount available on a 90-day SA deposit in money
market
(R1 000 000 * 1.02)
The rand profit above what could be generated by investing
in SA money market
(R1 037 172 – R1 020 000)
Gainmore Gutsa (51968932)
MYR317 360
MYR329 261
R1 037 172
R1 020 000
Unique Assignment # 647338
R17 172
INTERNATIONAL FINANCIAL MANAGEMENT
FIN4802: ASSIGNMENT 1
(d) Arbitrage opportunities are likely to disappear soon after they have been discovered
because of market forces that will lead to equilibrium as the supply and demand of the
Malaysian Ringgit and South African Rand will continue to adjust because of the action
of arbitragers until the mispricing is eliminated. The covered interest arbitrage with the
immediate purchase and sale of ringgit will exert upward pressure on the spot rate of
the ringgit and downward pressure on the ringgit forward rate until covered interest
arbitrage is no longer possible. The state of equilibrium is called interest rate parity
and at this point the forward premium or discount offsets the difference in interest rates
between South Africa and Malaysia.
Gainmore Gutsa (51968932)
Unique Assignment # 647338
INTERNATIONAL FINANCIAL MANAGEMENT
FIN4802: ASSIGNMENT 1
QUESTION 2
EFFECT OF CHANGES IN EXCHANGE RATE ON COSTS, REVENUE & CASH FLOW ITEMS OF MADISON Co.
SCENARIO 1: C$ = US$0.75
U.S. $M
Sales
U.S. business sales
Canadian business sales
Total sales in U.S. $
Cost of materials
U.S. business cost of materials
Canadian business cost of materials
Total cost of material in U.S.$
(C$4m*US$0.75)
320
3
323
(C$4m*US$0.80)
(C$200m*US$0.75)
50
150
200
(C$200m*US$0.80)
Operating expenses in U.S.$
Interest expense
U.S. business interest expense
Canadian business interest expense
Total interest expense in U.S.$
Cash flow in U.S.$ before taxes
SCENARIO 2: C$ = US$0.80
U.S. $M
(C$10m*US$0.75)
SCENARIO 3: C$ = US$0.85
U.S. $M
320
3.2
323.2
50
160
210
(C$4m*US$0.85)
(C$200m*US$0.85)
320
3.4
323.4
50
170
220
60
60
60
3
7.5
10.5
3
8
11
3
8.5
11.5
52.5
(C$10m*US$0.80)
(C$10m*US$0.85)
42.2
31.9
Comment:
A weaker U.S. dollar against the Canadian dollar, causes Canadian dollar sales, cost of materials, and interest expense converted to U.S. dollar to
continue to rise while overall net cash flow in U.S. dollars continues to decrease as long as U.S. business based sales are assumed not affected
by the change in exchange rates. Madison’s Canadian dollar cost of material and interest expense exposure (C$210m combined) is much greater
than its Canadian dollar sales exposure (C$4m) resulting in an overall negative impact on net profit before tax (cash flow before tax). In general,
Madison Co. is adversely affected by a stronger Canadian dollar and favourably affected by a weaker Canadian dollar.
Gainmore Gutsa (51968932)
Unique Assignment # 647338
INTERNATIONAL FINANCIAL MANAGEMENT
FIN4802: ASSIGNMENT 1
REFERENCE:
Madura, J & Fox, R. 2011. International financial management. 2nd edition. Cengage Learning.
Gainmore Gutsa (51968932)
Unique Assignment # 647338