Question

The exchange rates in New York are: $1 = AUD 1.2338 and $1 = £0.6106

A dealer is offering a quote: AUD 1 = £0.8328.

What is the profit you can earn on $7,198 using triangle arbitrage?

Please show work.

Answer 1

If we calculate the implied Pound/AUD rate, it comes out as: (Pound/$)/(AUD/$) = 0.6106/1.2338 = 0.4949 Pound/AUD

We can see that the implied rate is less than the actual rate which means that AUD is over priced in the spot market. Thus, AUD shpuld be sold at the spot rate to earn a profit. The following steps will should be undertaken to earn arbitrage:

1. Sell dollars to buy AUD: $7198*1.2338 = AUD 8,880.89

2. Sell AUD to buy Pound: 8880.89*0.8328 = 7,396.01 Pound

3. Sell Pound to buy $: 7396.01/0.6106 = 12,112.69 $

4. Gain = 12,112.69-7,198= 4,914.69