Question

Assume that the following spot exchange rates exist today: ₤1 = $1.50 C$ = $.75 ₤1 = C$2 Assume no transactions costs. Based on these exchange rates, can triangular arbitrage be used to earn a profit on an initial investment of $1,000,000? Explain. (Provide numerical support)

Answer 1

When exchange rate of three currencies don't match, a discrepancy occurs between three currencies, so in such a rare situation investors can benefit from triangular arbitrage;

I) sells $ dollars for GBP = £ 1000000×(1/1.5) =£ 666,666.67

( $ 1 = £ 1/1.5 )  

II) sells GBP (£) for C$ = C$ 666666.67 × 2 = C$ 1333333.34

( £1= C$2 )

III) sell C$ for US $ = USD 1333,333.34 ×0.75 = $1000,000

( C$1= US$ 0.75)

Thus ,the investor can't get profit here from the triangular arbitrage)