Peso arbitrage, or What to do with a morning in Davao

The Philippine peso: The most profitable currency arbitrage today.

If there’s a single place on earth today that Stephen Ross and Richard Roll ought to be, it must be the Philippines.

Ross and Roll, of course, are the famous financial economists who in 1980 developed the Arbitrage Pricing Theory (APT) of capital assets that owes its theoretical strength to one of the oldest laws of economics – the law of one price.

But there’s one asset class that is currently flaunting its violation of this law: the Philippine peso.

“I got an IDD call from my friend who is in Davao today,” says Jesse Llamas, a Filipino businessman who is in Hong Kong to attend a jewelry fair. “He said he has found a seller of dollars at Ps35. In Manila, the dollar costs Ps46.”

Currency arbitrageurs in the international market make money by exploiting price differentials measured in pips.

In the Philippines, this quirky price arbitrage of about 30% spread has caused several Manila businessmen to fly down to the southern city of Davao, the country’s third largest urban center, to purchase dollars from hole in the wall moneychangers.

Philippine Airlines (PAL) operates three Airbus 330, 105-minute daily flights to Davao costing Ps3,098 (about $67) one way on Mabuhay [business] Class.

He goes on board PAL flight PR809 ETD 0510H arriving at 0655H. He can leisurely proceed to the moneychanger who should open by 8 am. By 9 am, the entire transaction is completed. No receipts are issued; only a printout from a Casio calculator that shows the multiplication.

An enterprising Manila businessman would buy $50,000 dollars at Ps35 for a total of Ps1.75 million, which consists of 1,750 1000-peso bills – not a bulky cargo to carry inside an attachT case.

He gets back to Davao International Airport by 10 am, in time to get on board PR811 ETD 1100H arriving at 1245H in Manila’s new Millennium airport where his driver in his Toyota Prado awaits.

The quick-buck businessman immediately proceeds to the Binondo central bank, (the black market central bank located in Chinatown), sells the dollars at Ps46, and receives Ps2.3 million.

This same astute businessman realizes a profit of Ps550,000 for half a day’s work. The minimum-wage worker who earns Ps 223.50 per day would have to work for about 2,355 days, or 6.45 years to earn that money.

Always carry protection

The personal risk of carrying cash of this quantity is very high. The businessman should bring with him three bodyguards to Davao and to Binondo. But hiring bodyguards has a few flow-on effects: PAL will have more passengers; restaurants additional customers; and the country, fewer unemployed people.

We’re not being facetious regarding the bodyguards. High school students in Manila have been shot to death at 6 in the morning inside public buses for their Nokia 5110 cell phones.

But what’s causing this incredibly profitable arbitrage? Remember all those dollars that Libya paid for the liberty of the foreign hostages in Sulu island? That’s some $12 million, plus the earlier ransoms close to $6 million. These dollars have to be converted to pesos sooner or later, and in an area where there are probably more dollars than things to buy, the law of supply and demand takes precedence.

The provinces comprising the autonomous Muslim Mindanao have a population of only about 2.19 million.

Davao is in southern Mindanao, about 969 flight kilometers from Manila. It is inevitable that the dollars would flow towards the cities of Davao, Zamboanga, and even Cebu in central Philippines.

“I don’t have to know arbitrage pricing theory to know there is money to be made in this situation,” said Llamas, who has an MBA. “My friend is already out there helping himself to the ransom dollars.” But Llamas is not saying if he’s going to Davao after he returns to Manila on September 26 from his Hong Kong trip.

So, what are you waiting for? Get on board PR809 Airbus 330 tomorrow morning with your bodyguards. Just make sure you are in Mabuhay Class to avoid bringing attention to your entourage.

By the way, see that middle-aged gentleman in barong Tagalog in seat D2 with five other darker guys? Be careful, he’s from the open market trading department of the Bangko Sentral ng Pilipinas. He is also going to Davao to purchase $1 million from the same hole-in-the-wall moneychanger you’re going to. He is going to give a realistic meaning to the term “open market operation”.