An investment banker has $10,000,000 to invest in the foreign currency market. T

Question

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.

1. Based on the information provided in the previous question, which of the following will occur to eliminate the arbitrage opportunity?

a. The euro will appreciate against the dollar.

b. The pound will depreciate against the dollar.

c. The pound will depreciate against the euro.

d. None of the above

2. A money manager with $1,000,000 to invest notices that the dollar/yen exchange rate is quoted as ¥125/$ and the dollar/franc exchange rate is quoted at CHF.80/$. If a bank quotes you a cross rate of ¥156.25/CHF how much money can you make via triangular arbitrage (in terms of dollars)? Round intermediate steps to four decimals and your final answer to two decimals. Do not use currency symbols or words when entering your response.

3. How will currency prices adjust to eliminate the arbitrage opportunity in the previous question?

a. The yen will appreciate against the dollar.

b. The franc will depreciate against the dollar.

c. The franc will appreciate against the yen.

d. No adjustment is necessary since arbitrage was not possible.

4. Use the following to answer the next two questions.

You observed the following spot quotations for dollars and euros.

Bank X: $1.1033-37

Bank Y: $1.1032-38

Bank Z: $1.1029-32

Find the maximum arbitrage profit available (in terms of dollars) if you have 6 million dollars at your disposal. Round intermediate steps to four decimals and your final answer to two decimals.

a. 543.87

b. 4352.16

c. 4896.18

d. 0

5. In order for the arbitrage opportunity to be eliminated, bank Z's ask price must decrease. T/F

6. Triangular arbitrage opportunities occur when the actual cross rate equals the implied cross rate. T/F

Explanation / Answer

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

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

1. a. The euro will appreciate against the dollar.

2.Available Funds = $1,000,000

Convert into CHF = 1000000*0.8 = CHF80,000

Convert into Yen = Yen80,000*156.25 = Yen12500,000

Convert Back into Dollar = $ 12500,000/125 = $1,000,000

Hence, no arbitrage possible

3. d. No adjustment is necessary since arbitrage was not possible.

4.Buy Euro from bank Z and Sell to Bank X

Buy = 6000,000/1.1032 = Euro 5,438,723.71283

Sell = Euro 5,438,723.71283*1.1033 = $6,000,543.87

Arbitrage Gain = $543.87 i.e. a

5. false, ask price should increase

6.False. It occurs when actual rate is not equal to implied rate

Related Questions

Navigate

• Browse (All)
• Browse A
• Subjects

Integrity-first tutoring: explanations and feedback only — we do not complete graded work. Learn more.