Question

A money manager with $1,000,000 to invest notices that the dollar/yen exchange rate is quoted as ¥125/$ and the dollar/franc exchange rate is quoted at CHF.80/$. If a bank quotes you a cross rate of ¥156.25/CHF how much money can you make via triangular arbitrage (in terms of dollars)? Round intermediate steps to four decimals and your final answer to two decimals. Do not use currency symbols or words when entering your response.   

How will currency prices adjust to eliminate the arbitrage opportunity in the previous question?

		The yen will appreciate against the dollar.
		The franc will depreciate against the dollar.
		The franc will appreciate against the yen.
		No adjustment is necessary since arbitrage was not possible.

Answer 1

Investment Available = $ 1 million, Dollar-Yen Exchange Rate = Y 125/$, Dollar-Franc Exchange Rate = CHF 0.8/$ and Y 156.25/CHF

In order to execute triangular arbitrage one needs to undertake the following steps:

Convert $1 million into Yen to yield Y 125 million

Convert Y 125 million into CHF to yield = 125 / 156.25 = 0.8 million CHF

Convert 0.8 million CHF to $ to yield = 0.8 / 0.8 = $ 1 million

These set of steps indicate that there are no opportunities of a triangular arbitrage as no profit can be made.
Arbitrage Profit = $ 0

Hence, the correct option is (D).