Chapter 5 Solutions - The Market for Foreign Exchange...

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9 The Market for Foreign Exchange Chapter 5 Questions and Problems
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Question 9 What is triangular arbitrage? What is a condition that will give rise to a triangular arbitrage opportunity? Triangular arbitrage refers to the opportunity to earn arbitrage profit from trading between three currencies. Opportunities exist when the direct exchange rate between the second and third currencies is not in alignment with the cross-exchange rate.
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Question 9 Continued For example: Given the following exchange rates: €/$ = 0.6783 $/£ = 1.9712 €/£ = 1.3310 (direct market) or 0.7513£/€ Implied cross-rate: €/£ = €/$ * $/£ = 0.6783 * 1.9712 = 1.3371 1.3371 > 1.3310, therefore arbitrage profit is possible: $5,000 * 0.6783€/$ = 3,391.5€ 3,391.5€ * 0.7513£/€ = 2,548.08£ 2,548.08£ * 1.9712$/£ = $5,022.78 – $5,000 = $22.78 profit.
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From exhibit 5.4, calculate the cross rates (x-rates) for: € per SF € per ¥ € per £ SF per ¥ 1. € per SF = € per $/SF per $ = 0.6783/1.1067=0.6129 The cost of SF1.00 in Euros is €0.6129 2. € per ¥ = € per $/¥ per $ = 0.6783/108.46=0.00625
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Chapter 5 Solutions - The Market for Foreign Exchange...

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