Question

1) At Bank X, the bid rate of a NZD is USD 0.630 and the ask rate is USD 0.635. However, at Bank Y, the bid rate of the NZD is USD 0.628 and the ask rate is USD 0.631. What would be your profit if you use USD 1,000,000 and try to execute locational arbitrage?

A) + USD 11,146.50 B) + USD 1,587.30 C) - USD 1,584.79 D) - USD 11,023.62

2) At Bank X, the bid rate of a NZD is USD 0.632 and the ask rate is USD 0.635. However, at Bank Y, the bid rate of the NZD is USD 0.628 and the ask rate is USD 0.631. What would be your profit if you use USD 1,000,000 and try to execute locational arbitrage?

A) + USD 1,584.79 B) - USD 1,584.79 C) + USD 11,146.50 D) - USD 11,146.50   

3) In Tokyo the USD bid rate is JPY 110.55 and the USD ask rate is JPY 111.09, while in London the USD bid rate JPY 111.05 and the USD ask rate is JPY 111.60. What would be your profit if you use USD 1,000,000 and try to execute locational arbitrage?

A) -360.07 B) -336.96 C) -450.12 D) -512.39

4) In question (6), the data implies no profitable opportunity for locational arbitrage. But if the USD ask rate were _______, location arbitrage between Tokyo and London would become profitable, all else equal.

A) equal to JPY 111.05
B) less than JPY 111.05
C) greater than JPY 111.05 D) none of the above

Answer 1

1)

Bank X - Bid/ASk: 0.630/0.635

Bank Y- Bid/Ask: 0.628/0.631

In this type of questions, we have to buy NZD from bank which is offering it at lowest price, that is lowest ask price - which is bank Y in question. So, we will buy NZD from 1,000,000 USD. So, we get 1,000,000/0.631 = 1,584,786.05 NZD.

We will sell it at the bank offering highest bid price. so, we sell NZD to bank X, so we will get 1,584,786.05*0.630 = 9,98,415.21 USD. So, effectively we loose USD 1,584.79 (1,000,000 - 9,98,415.21) ; answer is C

2)

following same steps as explained above

Bank X: 0.632/0.635

Bank Y:0.628/0.631

first transaction: 1,000,000/0.631 = 1,584,786.05

second transaction; 1,584,786.05*0.632 = 1,001,584.79

effective gain is 1,584.79 ( 1,001,584.79- 1,000,000) hence answer A

3)

Same as above questions solved: ( just note that in Question 1 and 2 NZD price was given in USD while in thius question USD price is given in JPY; so we can buy/sell USD to get JPY at respective rates. SO, bid/ask rate is per usd in this queation while in first two question bid/ask was for NZD)

Tokyo: 110.55/111.09

London: 111.05/111.60

We will sell USD at place where we will get maximum JPY that is london

step 1: sell USD at london: 1,000,000*111.05 = 111,050,000

step 2: now we will sell this JPY for getting maximum USD, sell JPY at lowest ask price that is 111.09 at which we can get maximum USD back

111,050,000/111.09 = 999,639.931

so,effectively we loose 1,000,000-999,639.931 = 360.068 that is answer A

4) to become profitable : ask rate should be less than 111.05 then only step 2 in above answer will be 111,050,000/ (some thing less than 111.05) = something more than 1,000,000 and hence will result in profit. so answer is B.alternatively, One can put some asssumed value and check all the options.