Question

An investor notices that an ounce of gold is priced at $518 in London and $525 in New York (20m)

a) What action could be investor take to try to profit from the price discrepancy

b) Under which trading activities would this action be classified

c) What pattern should the two price take in the short term future

Please help, I need more detail on that

Answer 1

(a): The action that the investor should take is to buy gold in London and then sell it in New York. This is because price of gold is lower in London and so the investor will buy gold at a lower price. Selling it in New York at a higher price will enable the investor to earn a profit from this transaction.

(b): This will be classified as a “pure arbitrage” trading activity.

(c ): In the short term future the gold prices in New York may drop (although not substantially) and in London the prices may increase. This is because prices of gold tend to be volatile and the market will adjust for difference in prices in the two markets in the short term future. The prices will change in both markets in the short term future to reduce the extent of profitability that is currently available through the pure arbitrage strategy.