Question

1. National Bank quotes the following for the British pound and the New Zealand dollar:​

​	Quoted Bid Price	Quoted Ask Price
Value of a British pound (£) in $	$1.61	$1.62
Value of a New Zealand dollar (NZ$) in $	$.55	$.56
Value of a British pound in	​	​
New Zealand dollars	NZ$2.95	NZ$2.96

Equilibrium cross-exchange rate                                   NZ$2.875                        NZ$2.945

Assume you have $100,000 to conduct triangular arbitrage. Show step by step what transactions you will make and what is the arbitrage profit or loss? If arbitrage profit exists, what market forces would co-occur to eliminate the arbitrage opportunity? (5 points)

Answer 1

Given $100,000

From USD to GBP - value of british pound in terms of USD, (GBP/USD = 1.62).

Hence Pounds = 10,0000 * (1/1.62) = GBP 61,728.4

From GBP to NZD - value of british pound in terms of NZD

(GBP/NZD = 2.95), Hence NZD = 61,728.4 * 2.95 = NZD 182,098.8

From NZD to USD - the value of NZD in terms of USD is given and we need to sell NZD, (NZD/USD = 0.55), Hence USD = 182,098.8 * 0.55 = USD 100,154.3

10,015.43-10,000 = $154.3

In this method we got profit, which is very minimal

but it will be vanished through transactions cost so no profit can be made