Question

6.

A) You observe the following quotes for the USD/AUD in the spot market from two banks:

Bank of Sydney		Bank of New York
Bid	Ask	Bid	Ask
0.71711	0.71715	0.71708	0.71715

Do these quotes imply the possibility of earning a profit by using locational arbitrage? If so, calculate the potential profit if you are able to use AUD 25,000. If not, explain why arbitrage is not possible?

B) You observe the following quotes for the GBP /AUD in the spot market from two banks:

Bank of Melbourne		Bank of London
Bid	Ask	Bid	Ask
0.5458	0.5459	0.5514	0.5515

Do these quotes imply the possibility of earning a profit by using locational arbitrage? If so, calculate the potential profit if you are able to use GBP 50,000. If not, explain why arbitrage is not possible?

C) You observe the following quotes for the EUR / USD in the spot market from two banks:

Deutsche Bank		Bank of America
Bid	Ask	Bid	Ask
1.18102	1.18102	1.18094	1.18100

Do these quotes imply the possibility of earning a profit by using locational arbitrage? If so, calculate the potential profit if you are able to use EUR 500,000. If not, explain why arbitrage is not possible?

please, do not use the handwriting to help me and answer all parts (a , b , and c ) and step by step and in a very clear way

Answer 1

A) No, these quotes do not imply profit earning possibility using locational arbitrage. While buying a currency, we look at Ask price and while selling the currency, we look at Bid price. If we buy a USD from Bank of Sydney and sell it to Bank of New York, then buy will be at Ask of 0.71715 and sell would be at Bid of 0.71708, which will yield loss. Similary, if we reverse the transation and buy from Bank of New York and sell to Bank of Sydney, then buy will be at 0.71715 and sell will be at 0.71711, which will also yield loss. Hence, there is no arbitrage opportunity.

B) Yes, these quotes imply a profit earning possibility using locational arbitrage. The profit can be earned through below simultaneous transactions:

i) Sell 50,000 worth of GBP to Bank of London at Bid price of 0.5514.

ii) Buy GBP at Ask price of 0.5459 from Bank of Melbourne.

The transactions would yield a profit of 275 GBP (0.5514 - 0.5459) * 50,000.

C) Yes, these quotes imply a profit earning possibility using locational arbitrage. However, the profit would be negligible enough to be cancelled out in transaction cost. Below simultaneous transactions can earn the profits:

i) Sell 500,000 worth of EUR to Deutsche Bank at Bid Price of 1.18102.

ii) Buy EUR at Ask Price of 1.18100 from Bank of America.

The transactions would yield a profit of 10 EUR (1.18102 - 1.18100) * 500,000. If we consider transaction cost then this profit would not be there.