Question

A. Take the following two exchange rates and compute the EUR/INR cross exchange rate. INR12.1225/USD and EUR.8145/USD.

B. In question A, if there is a direct cross exchange rate of EUR.066215/INR, is there a triangular arbitrage opportunity? If yes, start with $50,000 and indicate how much triangular arbitrage profit exists for 1 trip around the triangle.

Answer 1

Hi,

Here 1 USD = 12.1225 INR

so 1 INR = 1/12.1225 USD

and 1 USD = 0.8145 EUR

we need to EUR/INR (i.e how many EUR in 1 INR)

so EUR/INR = (EUR/USD)*(USD/INR)

EUR/INR = 0.8145/12.1225

EUR/INR = 0.067189

That means 1 INR = 0.067189 EUR

B) Yes triangular opportunity exists because purchasing power parity rule has been violated here. Lets see below how.

You are having $50,000 USD. At first using EUR/USD exchange rate you will buy EUR from USD

1 USD = 0.8145 EUR

50,000 USD = 0.8145*50000 = $40,725 EUR

now using EUR/INR exchange rate you  will buy INR from EUR

1 EUR = 1/0.066215 INR

40725 EUR = 40725/0.066215 = $615041.9 INR

finally using INR/USD exchange rate you will buy USD from INR

1 INR = 1/12.1225 USD

615041.9 INR = 615041.9/12.1225 =$50,735.57

Hence total profit using arbitrage = 50735.57- 50000 = $735.5668

Thanks