Question

4. Hint

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, answer all parts (a , b , and c ) and step by step and in a very clear way

please, do not use the handwriting to help me

Answer 1

Sol:

Bid price: At this price seller sell the currency

Ask price: At this price buyer buy the currency

Arbitrage: difference between bid and ask price creates arbitrage possibility.

How to do:

1st, look for local currency

2nd, then as i have currency i will get benefit when i would sell it. So i have to look for bid price in my local bank

3rd, look for ask price in foreign bank because i have to buy from then at low price then i will reap benefit.

4th, calculate difference between currency. If positive there has arbitrage possibility otherwise not.

A) as an Australian local i have AUD 25000. Now if i want profit then i will try to sell my Currency and buy USD. If i want to sell AUD then i need to see bid price quote in sydney bank and Ask price in New York bank. Bid price in Sydney 0.71711 and ask price in New York bank 0.71715. Difference between currency = (0.71711 - 0.71715) = -0.00004. Here i am not getting any profit as difference between currency negative.So, here no possibility of arbitrage chance.

b) As an european local i have GBP 50000 i will try to sell GBP and buy AUD. Here i will sell at bid price of 0.5514 at bank of london and buy 0.5459 at bank of Melbourne. Difference between currency = (0.5514 - 0.5459)=0.0055. Here i have positive value so that i have profit in this arbitrage.

C) as an european local i have EUR500000. So i will try to find bid price of my local bank(Deutsche bank) to sell and need to see ask price of foreign bank(bank of america) to buy. Price difference between currency = (1.18102-1.18100)=0.00002. Here profit is available in this arbitrage.