Question

In March 8th 2020, In London 1 $ = £ 0.7656, while in Zurich 1 SF = $1.08, but you found out that at JP Morgan, the cross rate between CHF and GBP is: 1 SF = £ 0.9264.

If you are a trader at Citibank, and you have USD 1,000,000 for an arbitrage.

1. Is there any arbitrage profit that could be made with a triangular arbitrage action?
2. Describe an example of how such a profit may be earned (draw a similar triangular diagram referring to lecture slides page 18). Make sure to show your steps, and most importantly, the ending $ value.
3. What would you guess about the relationship between the dollar rates and cross-rates after arbitrageurs notice this profit opportunity?

Answer 1

GBP/USD	0.7656
USD/CHF	1.08
GBP/CHF	0.826848
GBP/CHF	0.9264
So it is clear that GBP is cheaper (or CHF more expensive) when bought using JP Morgan cross rate, as compared to the two step transaction (GBP/USD and USD/CHF)
Hence, we should first convert our USD into CHF in the open market, then use these CHF to buy GBP from JP Morgan, and finally use these GBP to get USD in the open market as follows:
Buy CHF	925925.9
Buy GBP	857777.8
Buy USD	1120399
We end up with $1,120,399 using the arbitrage described above