Question

Suppose the Japanese yen exchange rate is ¥75 = $1, and the British pound exchange rate is £1 = $1.54.

a. What is the cross-rate in terms of yen per pound? (Round your answer to 2 decimal places, e.g., 32.16.)

Cross-rate ¥/£

b. Suppose the cross-rate is ¥120 = £1. What is the arbitrage profit per dollar used? (Do not round intermediate calculations and round your answer to 4 decimal places, e.g., 32.1616.)

Arbitrage profit $

Answer #1

a) | $1 = yen 75 | |||||||

1 pound = $ 1.54 | ||||||||

yen per pound | ||||||||

Cross rate = 75*1.54 | ||||||||

115.5 | ||||||||

1 pound = Yen 115.50 | ||||||||

b) | If the cross rate is 1 pound = Yen 120 | |||||||

than the arbitrage profit would be | ||||||||

The yen is quoted high relative to the pound. So,take out a loan for $1 and buy £0.6494(1/1.54) | ||||||||

Use the pounds to purchase yen at the cross-rate, which will give you: £0.6494(¥120/£1) = ¥77.928 | ||||||||

Use the pounds to buy back dollars and repay the loan. | ||||||||

The cost to repay the loan will be: ¥77.928($1/¥75) = $1.03904 | ||||||||

The arbitrage profit is $0.03904 per dollar used. |

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