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Arbitrage Exercise With Answer

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26 views

Arbitrage Exercise With Answer

Uploaded by

nfasuhaimee
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© © All Rights Reserved
We take content rights seriously. If you suspect this is your content, claim it here.
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Arbitrage Exercise

Question 1
Jenny, a currency trader notices the following quotes:

US Market New Zealand Market


US$0.7180/95/NZ$ NZ$1.1334/38/C$
US$0.8016/52/C$

Jenny wishes to perform currency arbitrage by taking advantage of exchange rate of New
Zealand dollar per Canadian dollar. Explain the steps involved and compute profit from this
strategy if she has US$100,000 to trade.
(8 marks)
ANSWER
Triangular arbitrage

Cross rate of NZ$/C$


Bid: 0.8016/0.7195= NZ$1.1141/C$ √
Ask: 0.8052/0.7180 = NZ$1.1214/C$√

Compare with NZ market: NZ$1.1334/38/C$

The market is quoted C$ higher than its intrinsic value, the strategy is to
Buy C$ in US Market, sell C$ at NZ market √√
1. Buy C$ in US, (Bank Ask): US$100,000 / US$0.8052 = C$124,192.74 √√√
2. Sell C$ at New Zealand, (Bank Bid): C$124,192.74 x NZ$1.1334 = NZ$140,760.06√√√
3. Sell NZ$ (Bank Bid): NZ$140,760.06 x US$0.7180 = US$101,065.72√√√
4. Profit = US$101,065.72 – US$100,000 = US$1,065.72√√√

QUESTION 2
Speculators in foreign exchange trading always try to take advantage of imbalances in
foreign exchange rates between two foreign exchange markets. If the available quotations
are as below, calculate the profit made by a speculator who has MYR10,000 cash initially.

Malaysia Singapore
MYR2.9800/90/SGD
SGD1.8200/76/GBP
MYR5.4000/99/GBP

(8 marks)
ANSWER
If you have MYR10,000, determine your arbitrage profit.
First we need to find the cross rate of SGD/GBP in Malaysia.
Bid rate = Bid fc Ask rate = Ask fc
Ask hc Bid hc
= 5.4000 = 5.4099
2.9890 2.9800
= SGD1.8066/GBP = SGD1.8154/GBP
GBP is cheaper in Malaysia compared to in Singapore. Therefore:

i) Buy GBP in Malaysia = MYR10 000/MYR5.4099 = GBP1848.46


ii) Sell GBP in Singapore= GBP1848.46 x SGD1.8200 = SGD3364.20
iii) Sell SGD in Malaysia = SGD3364.20X MYR2.9800 = MYR10025.32
Profit made = MYR10025.32- MYR10000 = MYR25.32

QUESTION 3
The exchange rates quotations for Malaysia and Australia market are as follows:

Malaysia Australia
Spot rate MYR4.0710/40/USD AUD1.4850/75/USD
MYR2.9200/30/AUD

Based on triangular arbitrage, compute the profit in RM if the arbitrageur initial investment
amount is RM1million.

( 8 marks)
ANSWER
In KL, the spot cross rate of AUD/USD is:
Bid (4.0710 ÷ 2.9230) = AUD/1.3927/USD √
Ask (4.0740 ÷ 2.9200) = AUD/1.3952 /USD √

USD is offered at different prices; thus, triangular arbitrage is possible.


Since USD looks cheaper in Malaysia, the arbitraging steps should start by buying USD in
Malaysia, sell it in Australia. √

MYR  USD  AUD  MYR

1) Buy USD in Malaysia MYR1,000,000 ÷ MYR4.0740= USD245,459 √


2) Sell USD in Australia USD245,459 x AUD1.4850 = AUD364,506.62 √
3) Sell AUD in Malaysia AUD364,506.62 x MYR2.9200 = MYR1,064,359.32 √

Profit = MYR1,064,359.32 – MYR1,000,000 = MYR64,359.32 √√

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