Answer:
(a) Yes, there is a profit by making triangular arbitrage action. Profit starting with selling ¥1,000,000 in London will be ¥250,000. Detailed description is in explanation part.
(b)
The dollar-pound exchange rate will change in the way that pound will be depreciated because there is more supply of pound in New York market following a arbitrageur action as they notice the profit-making opportunity.
Cross rates after arbitrageurs notice will be adjusted to the point where there is no arbitrage opportunity occurs. In (a) example, keeping other exchange rate unchanged, the dollar-pound exchange rate will be adjusted to £/$ = 1.25.
Explanation:
(a)
Investor sell ¥1,000,000 in London to get £500,000 ( exchange rate £/¥ = 0.50).
Further, he sells these £500,000 in New York to get $500,000 ( exchange rate £/$=2.5)
Next, they sell $500,000 to get ¥1,250,000 in Tokyo ( exchange rate ¥/$=2.5)
=> Net profit is ¥1,250,000 - ¥1,000,000 = ¥250,000
(b)
Details have already been explained in the answer part.
Answer:
a) There are arbitrage opportunities using triangular arbitrage
b)The bank in will realise arbitrage opportunity and adjust the qoute accordingly
Explanation:
New York £/$=1 Tokyo ¥/$ = 2.5 London £/¥ =0.5
According to cross rates this should be 1/2.5 = 0.4 therefore there are arbitrage opportunities and would be exploited by
Sell 1000000¥ in London since it is overpriced and receive £500000 (1000000*0.5)
Sell £500000 in New York and receive $500000 (£/$=1)
Sell $500000 in Tokyo and receive ¥1250000 ($500000*2.5)
Therefore the profit is ¥1250000-¥1000000=¥250000
b) The bank will adjust qoute of New york will Raise the dollar pound exchange to 1.25 and the cross rate will remain at 2.5 (£/¥=1.25/2.5=0.5)
