Jackie Robinson is the lead trader specializing in cross-rate arbitrage at Bank
ID: 2803038 • Letter: J
Question
Jackie Robinson is the lead trader specializing in cross-rate arbitrage at Bank of America. At any point in time he has unfettered access to $1 billion for arbitrage purposes. He notices the following quotes: Quotes available from various banks: JP Morgan: Mexican Pesos / dollar = P 19.12 / $ Deutsche: Euro / dollar = € 0.9010 /$ Banko de Mexico: Pesos / Euro = P 20.0316 / € a) Ignoring transaction costs, does Jackie have an arbitrage opportunity based on these quotes? No credit unless you show your work. YES NO b) If there is an arbitrage opportunity, how much will Alice profit if she has $1 billion available for this purpose? c) Now consider transaction costs at Banko de Mexico where the bid-ask spread is P4.0000/€. Assume Banko de Mexico will buy euros for P20.0316/€ and will sell euros to traders like Jackie for P24.0316/€. Banko de Mexico will also sell Pesos to Jackie for €0.04882/P and will purchase Pesos from Jackie for euros at €0.041611/P. Would Alice still be able to make arbitrage profits? Yes or No? Explain your answer
Explanation / Answer
a)
Buy pesos at JP Morgan
You receive = 19.12*1 = 19.12 billion pesos
Sell Pesos and buy Euros at Banko de Mexico
You receive = 19.12 / 20.0316 = 0.954492 billion euros
Sell Euros and Buy Dollars at Deutsche
You receive = 0.954492 / 0.9010 = 1.059369 billion dollars
As, you receive profits, there is an Arbitrage (YES)
b)
Buy pesos at JP Morgan
You receive = 19.12*1 = 19.12 billion pesos
Sell Pesos and buy Euros at Banko de Mexico
You receive = 19.12 * 0.04882 = 0.9334384 billion euros
Sell Euros and Buy Dollars at Deutsche
You receive = 0.9334384 / 0.9010 = 1.036003 billion dollars
As, you receive profits, there is an Arbitrage (YES)
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