Answer the following questions. Each sub-part of the question is not related to

Question

Answer the following questions. Each sub-part of the question is not related to the other part. Be sure to provide a written explanation in order to receive full credit. a)Suppose you are a currency trader, and he observes the following exchange rates in the spot market: S£/US$ = 0.5133 SUS$/€ = 1.4568 S£/€ = 0.7192 ? You observe there is an arbitrage opportunity in trading £ and €, what should you do to capture the arbitrage profit? What is your arbitrage profit (measured in £)? Explain. (6 points) ? Also, discuss the adjustment mechanism (i.e., explain how the transactions you would eliminate the arbitrage profit). (9 points)

Explanation / Answer

Answer :-

For capturing the arbitrage opportunity i can deal in Euro ( € ) and pound ( £ )

I can check the rates via direct quote and indirect quote or through cross rates

Spot rate at present

S£/US$ = 0.5133

S£/US$= 1.4568

S£/€ = 0.7192

Therefore with the help of cross rate we find the rate of pound per euro

£/€ = S£/US$ * S£/US$ = 0.5133 * 1.4568 = 0.7477

And if we can exchange directly Euro € in pound £ the the rate is

S£/€ = 0.7192

There fore there is a arbitrage profit

The arbitrage profit is 0.7477 - 0.7192 = 0.02857 per Euro in pound

Related Questions

Navigate

• Browse (All)
• Browse A
• Subjects

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