Question

Suppose you get the following quotes from Bank A and B on Euro.

           

Bank A            Bid Ask     Bank B         Bid                   Ask

USD1.2610/EU USD1.2630/EUR USD1.2640/EUR USD1.2660/EUR

You realize that you can use local arbitrage to take advantage of the quotes difference. If you could put as much as $1 million into the arbitrage, how much would be your arbitrage profits? To get full credits, you need to include step by step instructions on how to carry out this strategy.

Answer 1

Bank A
Bid, $/Euro = 1.2610
Ask, $/Euro = 1.2630
Bank B
Bid, $/Euro = 1.2640
Ask, $/Euro = 1.2660
Step 1
Buy Euro from Bank A at Ask rate
Euro Inflow = $1000000/1.2630
	= Euro 791765.6
Step 2
Sell Euro in Bank B at Bid rate
S Inflow = Euro 791765.6*1.2640
= $1000792
Arbitrage profit = $1000792-$100000
= $792