Question

A company is working out of Vienna with operations in New York simultaneously calls Citibank in New York City and Barclays in London. The banks give the following quotes on the euro simultaneously.

Citibank NYC                               Barclays London                 

$1.2828–29/€                                       $1.2824–25/€                   

Using $2 million or its euro equivalent, determine whether the corporate treasury could make geographic arbitrage profit with the two different exchange rate quotes.

Answer 1

solution:

Given $2 million and the following quotes

Bank C - $1.2828–29/€

Bank B - $1.2824–25/€

There are two different arbitrage strategies that can be attempted. The first is to buy euros from bank B and then selll to bank C:

Buy euros Bank B:

Euros to be bought = $2,000,000*Euro/$1.2825

=1,559,454 Euros

Sell euros Bank C

Euros to be sold = 1,559,454 Euros *$1.2828/Euro

=$2000468

The profit/loss can be calculated by subtracting the original starting amount of dollars by post-arbitrage amount:

Profit/loss = $2000468 - $2,000,000

= 468

The second strategu involves buy euros from bank C and selling them to bank B:

Buy euros Bank C:

Euros to be bought - $2,000,000 *Euro/ $1.2829

=1,558,968 Euros

Sell euros Bank B:

Euros to be sold = 1,558,968 Euros * $1.2824/ Euro

= $ 1,999,221

The profit/ loss can be calculated by subtracting the original starting amount of dollars by the post- arbitrage amount :

Profit/Loss - $ 1,999,221 - $2,000,000

= -779.484

In the 1st instance, the arbitager make a profit and in second instance arbitrage cannot make a profit using these quotes.