Question

You can trade FM Inc.’s shares for $77 per share in the United States and for £50 in the UK. Assume a brokerage commission of $0.10 per share in the United States and £0.10 in the UK. A foreign exchange dealer quotes a bid price of $1.50 for each pound and offers them for $1.51. Show how can you capture arbitrage profit by trading FM shares.

Answer 1

Arbitrage profit can be captured by trading in FM Inc's shares as follows:

1. Buy 1 Share of Fm Inc's share in UK at £50. Amount payable including Brokerage will be £50.1

2. To pay such amount we have to buy £50.1 from foreign exchange dealer at $1.51 resulting in outflow of $1.51 * 50.1 = $75.5

3. Sell that 1 Share of in United States at $77. Amount realised will be net of brokerage i.e $0.1 resulting in Inflow of $76.9

So total Arbitrage profit i.e Inflow (Step 3) - Outflow (Step 2) = 76.9 - 75.5 = $1.4