Question

Alabama Bank is willing to buy or sell British pounds for $1.98. The bank is willing to buy or sell Mexican pesos at an exchange rate of 10 pesos per dollar. The bank is willing to purchase British pounds at an exchange rate of 1 peso = .05 British pounds. Show how you can make a profit from triangular arbitrage and what your profit would be if you had $100,000.
What are the gains by using locational arbitrage as in (b)? Explain.

Answer 1

If you had $100,000 Alabama Bank is willing to buy or sell British pounds for $1.98 then 50,505.05(($100,000/1.98)British Pount will get. After The bank is willing to purchase British pounds at an exchange rate of 1 peso = .05 British pounds then 1010101Pesos(50,505.05/0.05)will get.Finally 1010101Pesos converts at an exchange rate of 10 pesos per dollar then 101010.10$ will get.

1010.10$(101010.10$-100000$) will get a profit from triangular arbitrage.

arbitrage means buying and selling of securities, currency, or commodities in different markets or in derivative forms in order to take advantage of differing prices for the same asset.