Question

1. On the Tokyo Stock Exchange, Honda Motor Company stock closed at ¥2,907 per share on Monday, June 6, 2016. Honda trades as an ADR on the NYSE. One underlying Honda share equals one ADR. On June 6, 2016, the ¥/$ exchange rate was ¥107.57/$1.00.

At this exchange rate, what is the no-arbitrage U.S. dollar price of one ADR?

By comparison, Honda ADRs traded at $27.18. Do you think an arbitrage opportunity exists?

2. If Honda ADRs were trading at $31 when the underlying shares were trading in Tokyo at ¥2,907, what could you do to earn a trading profit? Use the information in problem 1 to help you, and assume that transaction costs are negligible.

Answer 1

1.

Honda Stock Price in Tokyo STock Exchange = ¥2,907

Spot rate = ¥107.57 per USD.

if arbitrage opportunity is zero then Value of one ADR in USD is calculated below:

U.S. dollar price of one ADR = ¥2,907 / ¥107.57

= $27.02

U.S. dollar price of one ADR is $27.02.

2.

if If Honda ADRs were trading at $31 when the underlying shares were trading in Tokyo at ¥2,907, and Spot rate is  ¥107.57 then arbitrage profit is calculated below:

Arbitrage profit = $31 - (¥2,907 / ¥107.57)

= $31 - $27.04

= $3.96

Arbitrage profit is $3.96.