Question

Please construct the arbitrage opportunity to capture risk-free profit when you see the price of a dually listed multinational firm stock is $100 on the New York Stock Exchange and $110 Japanese Yen on the Tokyo Stock Exchange. Assume that the exchange rate is such that 1 USD equals 105.6 Yen. And also explain what is likely to happen to prices as traders take advantage of this opportunity.

Answer 1

For an arbitrage opportunity, you need to buy at a lower price from NewYork exchange at $100 and sell it for a higher price at the Tokyo Stock Exchange for $110. So the risk-free profit booked in one trade is $10.

When people start buying from the New York exchange the demand for the stock rises hence the price increases similarly when there is more selling in Tokyo Stock exchange the supply of the stock increases which reduces the price or leads to a fall in price. This increase and decrease in price happen until a price equilibrium is achieved.