Money in Motion Jake Problem

CASES CASE 10.1 Money in Motion Jake Nguyen runs a nervous hand through his once finely combed hair. He loosens his once perfectly knotted silk tie. And he rubs his sweaty hands across his once immaculately pressed trousers. Today has certainly not been a good day. Over the past few months, Jake had heard whispers circulating from Wall Street—whispers from the lips of investment bankers and stockbrokers famous for their outspokenness. They had whispered about a coming Japanese economic collapse—whispered because they had believed that publicly vocalizing their fears would hasten the ­collapse. And today, their very fears have come true. Jake and his colleagues gather round a small television dedicated exclusively to the Bloomberg channel. Jake stares in disbelief as he listens to the horrors taking place in the Japanese market. And the Japanese market is taking the financial markets in all other East Asian countries with it on its tailspin. He goes numb. As manager of Asian foreign investment for Grant Hill Associates, a small West Coast investment boutique specializing in currency trading, Jake bears personal responsibility for any negative impacts of the collapse. And Grant Hill Associates will experience negative impacts. Jake had not heeded the whispered warnings of a ­Japanese collapse. Instead, he had greatly increased the stake Grant Hill Associates held in the Japanese market. Because the Japanese market had performed better than expected over the past year, Jake had increased investments in Japan from 2.5 million to 15 million dollars only 1 month ago. At that time, 1 dollar was worth 80 yen. No longer. Jake realizes that today’s devaluation of the yen means that 1 dollar is worth 125 yen. He will be able to liquidate these investments without any loss in yen, but now the dollar loss when converting back into U.S. currency would be huge. He takes a deep breath, closes his eyes, and mentally prepares himself for serious damage control. Jake’s meditation is interrupted by a booming voice calling for him from a large corner office. Grant Hill, the president of Grant Hill Associates, yells, “Nguyen, get the hell in here!” Jake jumps and looks reluctantly toward the corner office hiding the furious Grant Hill. He smooths his hair, tightens his tie, and walks briskly into the office. Grant Hill meets Jake’s eyes upon his entrance and continues yelling, “I don’t want one word out of you, Nguyen! No excuses; just fix this debacle! Get all of our money out of Japan! My gut tells me this is only the beginning! Get the money into safe U.S. bonds! NOW! And don’t forget to get our cash positions out of Indonesia and Malaysia ASAP with it!” Jake has enough common sense to say nothing. He nods his head, turns on his heel, and practically runs out of the office. Safely back at his desk, Jake begins formulating a plan to move the investments out of Japan, Indonesia, and Malaysia. His experiences investing in foreign markets have taught him that when playing with millions of dollars, how he gets money out of a foreign market is almost as important as when he gets money out of the market. The banking partners of Grant Hill Associates charge different transaction fees for converting one currency into another one and wiring large sums of money around the globe. And now, to make matters worse, the governments in East Asia have imposed very tight limits on the amount of money an individual or a company can exchange from the domestic currency into a particular foreign currency and withdraw it from the country. The goal of this dramatic measure is to reduce the outflow of foreign investments from those countries to prevent a complete collapse of the economies in the region. Because of Grant Hill Associates’ cash holdings of 10.5 billion Indonesian rupiahs and 28 million Malaysian ringgits, along with the holdings in yen, it is not clear how these holdings should be converted back into dollars. Jake wants to find the most cost-effective method to convert these holdings into dollars. On his company’s website he always can find on-the-minute exchange rates for most currencies in the world (Table 1). The table states that, for example, 1 Japanese yen equals 0.008 U.S. dollars. By making a few phone calls he discovers the transaction costs his company must pay for large currency transactions during these critical times (Table 2). Jake notes that exchanging one currency for another one results in the same transaction cost as a reverse conversion. Finally, Jake learns the maximum amounts of domestic currencies his company is allowed to convert into other currencies in Japan, Indonesia, and Malaysia (Table 3). (a) Formulate Jake’s problem as a minimum cost flow problem, and draw the network for his problem. Identify the supply and demand nodes for the network. (b) Which currency transactions must Jake perform in order to convert the investments from yen, rupiah, and ringgit into U.S. dollars to ensure that Grant Hill Associates has the maximum dollar amount after all transactions have occurred? How much money does Jake have to invest in U.S. bonds? 480 CHAPTER 10 NETWORK OPTIMIZATION MODELS TABLE 1 Currency exchange rates To Yen Rupiah Ringgit From Japanese yen 1 50 Indonesian rupiah 1 0.04 U.S. Dollar Canadian Dollar Pound Peso 0.01 0.0064 0.0008 0.00016 0.0002 0.000128 0.000096 0.001536 1 0.2 0.25 0.16 0.12 1.92 1 1.25 0.8 0.6 9.6 1 0.64 0.48 7.68 1 0.75 12 1 16 Mexican peso 1 Malaysian ringgit 0.008 Euro U.S. dollar Canadian dollar European euro 0.0048 English pound 0.0768 TABLE 2 Transaction cost, percent From To Yen Rupiah Ringgit Yen — U.S. Dollar Canadian Dollar Euro Pound Peso 0.5 0.5 0.4 0.4 0.4 0.25 0.5 — 0.7 0.5 0.3 0.3 0.75 0.75 Ringgit — 0.7 0.7 0.4 0.45 0.5 U.S. dollar — 0.05 0.1 0.1 0.1 — 0.2 0.1 0.1 — 0.05 0.5 — 0.5 Rupiah Canadian dollar Euro Pound Peso — TABLE 3 Transaction limits in equivalent of 1,000 dollars To From Yen Rupiah Ringgit U.S. Dollar Canadian Dollar Euro Pound Peso Yen — 5,000 5,000 2,000 2,000 2,000 2,000 4,000 Rupiah 5,000 — 2,000 200 200 1,000 500 200 Ringgit 3,000 4,500 — 1,500 1,500 2,500 1,000 1,000 (c) The World Trade Organization forbids transaction limits because they promote protectionism. If no transaction limits exist, what method should Jake use to convert the Asian holdings from the respective currencies into dollars? (d) In response to the World Trade Organization’s mandate forbidding transaction limits, the Indonesian government introduces a new tax that leads to an increase of transaction costs for transaction of rupiah by 500 percent to protect their currency. Given these new transaction costs but no transaction limits, what c­ urrency transactions should Jake perform in order to convert the Asian holdings from the respective currencies into dollars? (e) Jake realizes that his analysis is incomplete because he has not included all aspects that might influence his planned currency exchanges. Describe other factors that Jake should examine before he makes his final decision. (Note: A data file for this case is provided on the book’s website for your convenience.)