Question

Assume the following information: Chase Wells Fargo Bid price of Malaysian ringgit MYR 4.5 / $ MYR 4.3 / $ Ask price of Malaysian ringgit MYR 4.4 / $ MYR 4.2 / $ (Note: All exchange rates here are quoted in the indirect way). Given this information, is locational arbitrage possible? If so, compute the profit from this arbitrage if you had $1,000,000 to use. What market forces would occur to eliminate any further possibilities of locational arbitrage?

Answer 1

1)

The arbitrager here deals with USD ($)

He is having $ 1000000 to use.

GIven

Ask price of Malaysian Ringgit for Us Dollar is 4.4 MYR per 1 USD and 4.2 MYR per 1 USD, which means that 1 MYR can be purchased by $ 0.22727272 (1/4.4) and $23809538 (1/4.2)

Bid Price of Malaysian Ringgit for US Dollar is 4.5 MYR per 1 USD and 4.3 MYR per 1 USD, which means that 1 MYR can be sold at $ 0.22222222 (1/4.5) and $ 0.23255814 (1/4.3)

Observing above ask and bid quotes, there exists an arbitrage profit, where an arbitrage can purchase Malaysian Ringgits at the rate of $ 0.22727272 per Ringgit and sell the same at the rate of $ 0.23255814 per Ringgit. This will earn him gain of $ 0.00528542 per Ringgit.

Generally in Forex Trading

Since the arbitrage is having $ 1,000,000, he can purchase 4400000 Ringgits (1000000/0.22727272) at the rate of $ 0.22727272 and sell them for $ 1,023,256 (4400000x0.23255814) at the rate of $ 0.23255814.

Thus the locational arbitrage profit is $ 23,256 (1023256-1000000).

2)

Generally in the Forex Trading, Triangular Arbitrage Gain may be possible, where 3 currencies are involved amd this will be due to market undervaluation of one particular currency in global Forex market. By taking advantage of this, arbitrage gain can be earned.

But here in the given case, the arbitrage gain is possible within nation between 2 currencies only i.e 1 domestic currency and 1 foreign currency. Because the domestic currency is having difference in ask price and bidding price within the nation. This is because the currecny is differently valued in the various locations of a country. This has given opportunity for locational arbitrage gain.

The place where the USD for MYR is less, there shall be less bidding and more asking, and at the place where the USD for MYR is high, there shall be more bidding and less asking. This disparity is the eason for locational arbitrage. Synchronization of various locational markets into one synergy can eliminate further possibilities of locational arbitrage.