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Session 14 - 16 Triangluar Abritrage

Triangular arbitrage involves taking advantage of exchange rate discrepancies between three currency pairs to generate risk-free profits. It involves exchanging one currency for a second currency, then the second for a third, and finally exchanging the third back to the original currency. Opportunities tend to be short-lived, often lasting just seconds. While profitable, most arbitrage opportunities provide only small potential profits of around $100 per $1 million traded due to small exchange rate differences of around 1 basis point. The process involves identifying an arbitrage opportunity between currency pairs, calculating implied versus direct exchange rates, and executing trades to lock in profits from any rate imbalances.

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74 views29 pages

Session 14 - 16 Triangluar Abritrage

Triangular arbitrage involves taking advantage of exchange rate discrepancies between three currency pairs to generate risk-free profits. It involves exchanging one currency for a second currency, then the second for a third, and finally exchanging the third back to the original currency. Opportunities tend to be short-lived, often lasting just seconds. While profitable, most arbitrage opportunities provide only small potential profits of around $100 per $1 million traded due to small exchange rate differences of around 1 basis point. The process involves identifying an arbitrage opportunity between currency pairs, calculating implied versus direct exchange rates, and executing trades to lock in profits from any rate imbalances.

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brownpie2019
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TRIANGULAR

ARBITRAGE
WHAT IS TRIANGULAR ARBITRAGE
CONT..

• Triangular arbitrage is a form of profit-making by currency traders in which they take


advantage of exchange rate discrepancies through algorithmic trades.

• To ensure profits, such trades should be performed quickly and should be large in size.

• The trader would exchange an amount at one rate (EUR/USD), convert it again
(EUR/GBP) and then convert it finally back to the original (USD/GBP), and assuming
low transaction costs to net a profit.
EMPIRICAL EVIDENCE

• A study examining exchange rate data provided by HSBC Bank for the Japanese
yen (JPY) and the Swiss franc (CHF) found that although a limited number of arbitrage
opportunities appeared to exist for as many as 100 seconds, 95% of them lasted for 5
seconds or less, and 60% lasted for 1 second or less.

• Further, most arbitrage opportunities were found to have small magnitudes, with 94% of
JPY and CHF opportunities existing at a difference of 1 basis point, which translates into
a potential arbitrage profit of $100 USD per $1 million USD transacted.
The Process Of Completing A Triangular Arbitrage Strategy
With Three Currencies Involves Several Steps:

1. Identifying a triangular arbitrage opportunity involving three currency pairs,

2. Identify the cross rate and implied cross rate

3. If a difference in the rates from step 2 is present then, trade the base currency for a second currency

4. Then trade second currency for a third. At this stage, the trader is able to lock in a no-risk profit due to
the imbalance that exists in the rates across the three pairs,

5. Converting the third currency back into the initial currency to take a profit.
PROBLEM 1 WHERE INFORMATION IN GIVEN IN ONE WAY QUOTE

AS AN EXAMPLE, SUPPOSE YOU HAVE $1 MILLION AND YOU ARE PROVIDED WITH THE
FOLLOWING EXCHANGE RATES: EUR/USD = 0.8631, EUR/GBP = 1.4600 AND USD/GBP = 1.6939.

• With these exchange rates there is an arbitrage opportunity:


1. Sell dollars for euros: $1 million x 0.8631 = €863,100
2. Sell euros for pounds: €863,100/1.4600 = £591,164.40
3. Sell pounds for dollars: £591,164.40 x 1.6939 = $1,001,373
4. Subtract the initial investment from the final amount: $1,001,373 - $1,000,000 = $1,373
• From these transactions, you would receive an arbitrage profit of $1,373 (assuming no
transaction costs or taxes).
PROBLEM 2:

• Given three different forex market information

• USD = INR 48.30 (Mumbai)


• GBP 1 = INR 77.52 (in London)
• GBP 1= USD 1.6231 (New York)

• The arbitrager has US $ 100,00,000. Assuming that there are no transaction cost. Explain
whether there is any arbitrage gain from the quoted spot exchange rates.
• USD= INR 48.30 (Mumbai ------------------------------INR /$= 48.30
• GBP= INR 77.52 (London) ------------------------------INR/GB
• This quote is US.
• GBP= USD = 1.6231 (New York ---------------------USD/GBP ---- Sell
i.e, $ is the home
currency.

• Therefore, we will • Cross rate Formula:  C/A= C/B *B/A


freeze this quote.

• Through these • (INR gets cancelled)


two rates, we will
find cross rate for
USD/GBP
• On the other hand, we use
USD/GBP reciprocals as the quote for
INR/USD given.
To convert into USD/INR, we
USD/GBP = 1.60497 -----Buy take reciprocal of it.
RULES :

• When ever the quotations are given in direct quote. In case the INR, the final result
should be in INR
Arbitrage Process
Step 1 Sell $ 1 Cr in Mumbai @ 48.30 = RS. 48.30 * 100,00,000 = Rs 48,30,00,000

Step 2 Then buy GBP in London @ 1 GBP =INR 77.52.


GBP ? = Rs 48, 30,00,000
GBP? = Rs 48, 30,00,000 /77.52
= GBP 6230650

Step 3 Sell GBP 6230650 at new York @ $ 1.6231.


1 GBP =1.6231$
GBP 6230650 = Dollar?
USD$???? = GBP 6230650 * 1.6231
= USD1,01,12, 968.27
Step 4 Initial amount what he had – 1 cr $
After transactions: 1,01,12, 968
Profit ==USD $ 1,12,968
Problem 3: Information on FOREX Quotations Given

Given three different forex market information


Currency Pair Quote Market
USD = INR 81.27Mumbai
GBP 1 = INR 98.58London
GBP 1= USD 1.21New York

Arbitrager from India has RS 50,00,000. Is there any


possibility of Arbitrages?
CROSS RATES FOR *

Step 2
RS/ USD

Calculated Value using Cross Rates 81.47107438

Actual Value@ New York Market 81.27


at the
Arbritage Process rate Amount

Sell RS to buy $ 50,00,000 81.27 $ 61523.31734

Sell $ to buy 61523.31734 1.21 50845.71681

Sell to buy INR 50845.71681 98.58 INR 5012370.763


Step 4: Calculate Gains
Gains (RS)
Initial Amount 50,00,000
Amount after
Transactions 5012370.763
Gains 12,371
Problem 4: FOREX Quotation are provided.

Currency Exchange Rate


€/JPY – Euro per Yen €0.0068
$/JPY – U.S dollar per Yen $0.0096
€/$ – Euro per U.S dollar €1.05

ARBITRAGER HAS 50000 JPY. IDENTIFY IF THERE IS ANY


TRIANGULAR ARBITRAGE AVAILABLE FOR THE ARTIBTRAGER???
SOLUTION
1. First, he converts the JPY into dollars = JPY 50,000 x $ 0.0096 = $ 480

2. Then he converts $ into Euros = $480 x €1.05 = € 504

3. Finally, the trader converts the euros into the initial currency, i.e., JPY, to
cash profits = € 504 / 0.0068 = JPY 74,117.6470

4. Thereby, the Japanese trader will earn profits worth JPY 24,117.647 through
triangular arbitrage on an initial investment worth JPY 50,000.
Problem 5. From following 3 quotes, examine if any arbitrage gains are possible, if the
arbitrager has SGD 1 million

• 64.85 JPY per SGD


• 0.0113 CHF per JPY
• 0.7345 CHF per SGD

• Find if there are any arbitrage available.

(Ans.: SGD 2,313/1 million SGD)


64.85 JPY PER SGD
0.0113 CHF PER JPY
0.7345 CHF PER SGD

Strategy 1: SGD  CHF  JPY  SGD

• Sell SGD for CHF  10,00,000 SGD * 0.7345  734500 CHF


• Sell CHF for JPY  734500 CHF / 0.0113  65000000 JPY
• Sell JPY for SGD  65000000 JPY / 0.6485  1002313.03 SGD

• Amount received after arbitrage - Total Initial Investment


• 1002313.03 SGD - 1000000 SGD  2313.03 SGD
64.85 JPY PER SGD
0.0113 CHF PER JPY
0.7345 CHF PER SGD

Strategy 2: SGD  JPY  CHF  SGD

• Sell SGD for JPY  10,00,000 SGD * 0.6485  6,48,50000 JPY


• Sell JPY for CHF  6,48,50000 JPY * 0.0113  7,32,805 CHF
• Sell CHF for SGD  7,32,805 CHF / 0.7345  997692.30 SGD

• Amount received after arbitrage - Total Initial Investment


• 997692.30 SGD - 1000000 SGD  (2307.69 SGD)
PROBLEM 7: FOREX QUOTATIONS

• Euro/ GBP =1.36 euro


• $ / GBP = 1.69 $
• Euro / $ =0.826 Euro
The arbitrager has 5000 $. Find if there is any triangular arbitrage possible.
STRATEGY 1

$  GBP  EURO  $ = 4871.26 (LOSS)


STRATEGY 2
$  EURO  GBP  $ = 5000$  4130 EURO  3036.76 GBP  5132.13 $
TRIANGULAR ARBITRAGE – TWO WAY
QUOTE
PROBLEM 3:

In The New York Market, The Following Price Of EURO Is Quoted As Follows
$/€ = 1.2500 – 1.2600

IN LONDON, THE VALUES OF US DOLLAR AND EURO AGAINST BRITISH POUND ARE
AS FOLLOWS
$/£ = £1.5650 -----£1.5750
€/£ = 1.2200 ---- 1.2300

THE ARBITRAGER HAS 12,600 $. IS THERE ANY ARBITRAGE AVAILABLE IN THE


EXCHANGE RATES QUOTED AT NEW YORK MARKET AND LONDON? IF SO WHAT
ACTION WOULD BE TAKEN TO EXECUTE THE ARBITRAGE €
• Solution : We will find synthetic rate for euro in terms of US dollar in London
Market.

a) Formula  Bid *
=1.5650*1/1.2300 = 1.2724

b) Formula 
= 1.2910
The exchange rate in New York and London are therefore as follows

In New York Market $/€ 1.2500 1.2600

In London (Synthetic) $/€ 1.2724 1.2910

One can buy Euro at $ 1.2600 in New York and Sell


Euro in London @ 1.2724 to gain $ 0.0124
The steps in arbitrage (The arbitrager has 12,600 $)

1. Sell US $ 12,600 in New York for Buy 10,000

2. Sell 10,000 to get Pounds  10,000 / 1.2300 = 8130.08

3. Sell 8130.08 to get $ 1.5650 * 8130.08 =$1274

4. Profit Margin  12724 – 12600 =124 $

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