Question

You are the finance manager of a company and currently your company has $100 million in cash that will not be needed for a few more weeks. You are thinking about arbitrage opportunities using Euro and GBP in order to put the cash reserves into use and hopefully earn more money for your company. You have to make a decision about details of your arbitrage with regard to which currency to buy in which order. Check exchange rates, find current rates for USD, Euro, and GBP, and share the details of your arbitrage plan with your CEO. Is it poosible to find an arbitrage trade to generate some profits (assume you will have no trading costs)? If so, what should be the order of your transactions in order to make a profit from this arbitrage operations?

I received a response stating "need enough knowledge" and about "exchange rates". I am not sure what that means, please elaborate instead of 2-3 word responses.

Answer 1

I will break things down logically. At the outset, these types of questions usually give foreign exchange rates, such as the worth of GBP in USD terms, worth of Euro in GBP terms, worth of USD in Euro terms, etc.

Then, you are expected to find out if we can buy some foreign currency using home currency, then convert the foreign currency to another foreign currency, and then convert this second foreign currency to home currency (or in any other order). This could result in us getting more than what we used in the first place. This is called Arbitrage Gain.

Now, because the question does not give the foreign exchange rates, some experts here asked you to provide the same. However, the question already says "Check exchange rates, find current rates for USD, Euro, and GBP". So, we need to take it from current foreign exchange rates.

Answer:
Exchange Rates: These are the foreign exchange rates on the 5th of October, 2019 at 11:22 AM (UTC) [Actual data]:

• 1 USD = 0.81 GBP
• 1 GBP = 1.12 Euro
• 1 Euro = 1.10 USD

Order of Transactions for Arbitrage:
You have 100 million USD. (given)
1. Buy Euro with 100 million USD = 100 million USD x 1/1.1 = 90.909090 million Euro
2. Buy GBP with 90.909090 million Euro = 90.909090 million Euro x 1/1.12 = 81.168830 million GBP
3. Buy USD with 81.168830 million GBP = 81.168830 million GBP x 1/0.81 = 100.208432 million USD.

So, you invested $100 million and secured $100.20843 million, indicating an arbitrage loss of $0.208432 million.

Hope this helps.
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