Question

1. The peso/pound exchange rate is Mex$16/£ while the euro/pound exchange rate is €1.15/£ . You also observe that the actual peso/euro cross exchange rate is Mex$12/€ . Find the triangular arbitrage profit (in pounds) available to someone that has access to £3,000,000. Round intermediate steps to four decimals and your final answer to two decimals. Do not use the dollar sign when entering your answer.

2. Which of the following would occur to eliminate the arbitrage opportunity?

a. No changes are necessary.

b. The pound will appreciate against the euro.

c. The pound will appreciate against the peso

d. None of the above

3. Suppose a banker observed the following spot quotations for dollars and euros.

Bank A: $1.0956-.62

Bank B: $1.0958-.63

Find the abritrage profit available (in terms of dollars) to a banker with 2 million dollars at her disposal. Round intermediate steps to four decimals and your final answer to two decimals.

a. 730.06

b.1277.84

c. 182.45

d. 365.10

e. 0

4. Locational arbitrage is possible when:

a. The bid price for a given currency in two locations is different.

b. The ask price for a given currency in two locations is different.

c. The bid price for a given curreny in one location is greater than the ask price in another location.

d. The ask price for a given currency in one location is greater than the bid price in another location.

5. An investment banker has $10,000,000 to invest in the foreign currency market. The dollar-euro exchange rate is quoted as $1.50/ € and the dollar-pound exchange rate is quoted at $1.60/£. If a bank quotes a cross rate of €1.10/£, how much money can she make (in terms of dollars) via triangular arbitrage if she is charged a 2% interest rate on borrowed funds? Round intermediate steps to four decimals.

a. 312,500

b. 112,500

c. 0

d. 1,420,833.33

Answer 1

1 pound = Mex$16

1 pound = Euro1.15

As per cross rate, 1 Euro should be equal to Mex$13.9130 (16/1.15)

Actual rate is 1 Euro = Mex$12

Hence, arbitrage is possible

Available funds = 3000,000 pounds

Converting into Mex$

3000,000*16 = 48,000,000 Mex$

Converting into Euro= 48,000,000/12 = Euro 4,000,000

Converting back into Pounds = 4,000,000/1.15 = Pounds 3,478,260.87

Arbitrage Profit = Pounds 478,260.87

2. b. The pound will appreciate against the euro

Which will correct the position

3.e 0

Since selling rate of both the banks is greater than buying rate of the other bank

Hence, no arbitrage possible

4. c. The bid price for a given curreny in one location is greater than the ask price in another location.

We will get a currency for lower price and can sell at higher price

5.Available funds = $10,000,000

Converting into Pound = 10,000,000/1.6 =Pound 6250,000

Converting into Euro = Euro 6250,000*1.1 = 6875,000

Back into Dollars = 6875,000*1.5 = $10,312,500

Arbitrage Profit = $312,500

1. 312,500

No interest since the entire process is completed on the same day and hence, no interest cost