If the direct quote for converting Canadian dollars to euros is 0.7488 and the c

Question

If the direct quote for converting Canadian dollars to euros is 0.7488 and the cross rate for Canadian dollar-euro is 0.7479, what three simultaneous trades could you make to profit from the arbitrage opportunity created by this pricing differential?

A. Trade U.S. dollars for euros, trade euros for Canadian dollars, and trade Canadian dollars for U.S. dollars.
B. Trade Canadian dollars for U.S. dollars, trade U.S. dollars for euros, and trade euros for Canadian dollars.
C. Trade U.S. dollars for Canadian dollars, trade Canadian dollars for euros, and trade the euros for U.S. dollars. D. Trade euros for U.S. dollars, trade U.S. dollars for Canadian dollars, and trade Canadian dollars for euros.

Explanation / Answer

Answer: B. Trade Canadian dollars for U.S. dollars, trade U.S. dollars for euros, and trade euros for Canadian dollars.

Explanation:

To make profit, euros have to be bought through the cross rate and then those euros have to be sold to get back into canadian dollars. So, the start is with canadian dollars with which US dollars would be bought which, is then exchanged for euros. Those euros are sold to get back to canadian dollars.

For instance, if one has 1000 Canadian dollars, he can buy 1000/0.7479 = 1337.0771 euros through the cross rate and then those euros can be sold to get 1337.0771*0.7488 = 1001.2034 Canadian dollars. The arbitrage gain would be Canadian dollars 1.2034 per 1000 Canadian dollars so traded.

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