Question

In: Finance

1) A bank manager with 11,000,000 Swiss francs (CHF) to invest in the foreign currency market...

1) A bank manager with 11,000,000 Swiss francs (CHF) to invest in the foreign currency market notices the current franc/US dollar exchange rate is CHF1.1/$ and the current Mexican peso/franc exchange rate is MP25/CHF. If a bank quotes a cross rate of $.03/MP, how much money can she make (in terms of francs) via triangular arbitrage? Round intermediate steps to four decimals and your final answer to two. Do not use currency symbols when entering your answer.

2) The peso should appreciate against the dollar to prevent the arbitrage opportunity found in the previous question.

True

False

Solutions

Expert Solution

In order to find out the profit we will follow the following steps .

Step 1 : Draw the triangle with various nodes showing various transactions.

Step 2 : We have 11,000,000 CHF to invest hence we will start with the node A.

We shall sell CHF and buy Dollar @ CHF1.1 / $

We will get 11000000/1.1 = $10,000,000

( Here the exchnage rate has CHF as price currency and we have to buy the base currency hence we have divided the amount by exchange rate.)

Step 3 : We shall sell Dollars and buy MP @$0.03 /MP

We shall get 10000000 /0.03 = MP 333,333,333.33

( Here the exchange rate has MP as base currency and we have to buy MP hence we have divided the amount by exchange rate)

Step 4 : We shall sell MP and buy CHF @ MP 25/CHF

We shall get 333,333,333.33 /25 = CHF 13,333,333.33

( Here the exchange rate has CHF as base currency and we have to sell MP hence the amount has been divided by the exchange rate)

Step 5 : Profit = 13333333.33 - 11000000

= $2,333,333.33

2) False - The peso should appreciate against dollar to prevent the arbitrage opportunity.

jeff jeffy answered 1 year ago
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