Question

You are looking at the markets for THB (Thai bahts) and EUR. You observe that the bid/ask interest rates in Thailand are 20%/22%, and the bid/ask interest rates on the euro are 2%/4%. The spot exchange rate is 40.1 THB/EUR, and you expect that in the next 3 months (90 days) the exchange rate will not move much, moving to 42.1 THB/EUR.

Your borrowing capacity is 2 million EUR and 50 million THB.

Based on this information, you decide to borrow EUR at the relatively low rates, and invest in the higher THB rate. What will be your profit as measured in EUR?

Answer 1

Bid/ask interest rates in Thailand = 20%/22%

Bid/ask interest rates in Euro = 2%/4%

Spot exchange rate = 40.1 THB/EUR

The exchange rate in the next 3 months (90 days) = 42.1 THB/EUR

Borrowing capacity = 2 million EUR and 50 million THB

Now the strategy is to borrow EUR at the relatively low rates, and invest in the higher THB rate

So, as the borrowing capacity of eur is 2 million EUR

It will be borrowed at the ask rate of 4% for 3 months

So, Interest cost = 2 million EUR * 4% * 3/12 = 20,000 EUR

Now, EUR will be converted in THB @ exchange rate of 40.1 THB/EUR and invested at the BId rate of 20%

2 million EUR = 40.1 * 2 million THB = 80.2 million THB

After 3 months, Interest Received = 80.2 million * 20% * 3/12 THB = 4.01 million THB

Total amount received after 3 months = 80.2 million + 4.01 million THB = 84.21 million THB

Now the THB will be converted in EUR @ exchange rate of 42.1 THB/EUR

84.21 million THB = 84.21/42.1 = 2,000,237 EUR

Profit on artbitrage = 2,000,237 EUR - 2 million EUR - 20,000 EUR = (19,763) EUR