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Mary, meanwhile has taken a few deep breaths on the terrace in an attempt to overcome her shopping fiasco. As she come back to her desk, she sees her computer terminal flashing with the following FOREX quotes: 1.1837 EUR/USD 0.7231 EUR/GBP 1.6388 GBP/USD page 3 As usual, she is required to check whether she can use them to earn some profit for her institution. She calls Nancy Williams, the department head, to ask how much funds can be allocated to participate in the FOREX market today. She gets an approval for 10,000 Euros and proceeds to examine the above FOREX quotes for a potential profit-making opportunity.

Will Mary be able to earn some profit for her institution by playing the FOREX market by using the quotes she saw on her screen when she returned from the terrace after the shopping disaster? If so, compute the profit. What is such type of profit called?

Answer 1

This is a case of Triangular arbitrage. Where we start with once currency in hand and then end up with the same. The resultant difference is an arbitrage profit/ loss.

We shall carry out the following steps to check if we can earn profit. We have 10000 EUROS.

Step 1 : Sell 10000 euros to buy USD @ 1.1837 EUR/USD

We get 10000 / 1.1837 usd = 8448.08651 USD

( We have divided the 10000 EUR by the quote as the EUR is the price currency in the quote )

Step 2 :

Sell 8448.08651 USD to buy GBP @ 1.6388 GBP / USD.

We get 8448.08651 * 1.6388 ie 13844.7242 GBP.

( We have multiplied the usd amount amount here as the quote is having usd as base currency)

Step 3 :

Sell 13844.7242 GBP to buy EUR @ 0.7231 EUR/ GBP

We get 13844.7242 * 0.7231 ie 10011.1201 USD.

( We have multiplied the GBP amount here as the quote is having usd as base currency)

Profit = 10011.1201 - 10000

= $11.1201