This week’s homework is divided into two parts. First, please answer the 2 questions below. Second, you will develop a trading strategy based on a concept known as “triangular arbitrage.” Below you will find links to four brief videos explaining the concept & how to test for its existence.
Part I
1. For purposes of this worksheet, assume the following exchange rates.
EURUSDbid = 1.20
EURUSDask= 1.205
CADUSDbid=.650
CADUSDask=.651
A. Are these direct (American) or indirect (European) ?
Direct
B. Suppose an American exporter has just received a payment of € 100,000, how many dollars will result upon conversion?
€100,000*1.20=$120,000
C. Suppose an American restaurant budgets $10,000 to restock its wine cellar with French wine. How many euros does it have to spend.
$10,000/1.20=€8,33.33
D. Suppose a Canadian investor wants to purchase $100,000 worth of U.S. Treasury bonds. What is the CAD cost of this investment?
$100,000/0.650=153,846 CAD
2. For the following problems assume that there are no bid/ask spreads and that EURUSD =1.20 and CADUSD =.60.
A. What is the quote, in Canadian dollars for euros?
EUR/CAD=2
B. What is the quote in euros for Canadian dollars?
CAD/EUR/0.5
C. Suppose that you are a currency trader and you see the quotes described above, but you also notice that in London they are giving quote of CADEUR =.505. Does this present an arbitrage opportunity, and if so, how much money can you make with an initial investment of $1,000,000?
$1,000,000=1,666,666.67 CAD=841,666.668EUR=$1,010,000 make $10,000 as profit
Part II
Cross Rates and Triangular Arbitrage. Let’s look more closely at question 2 above. In this section I'll take you through a series of four videos examining the possibility of generating a profit through triangular arbitrage. Triangular arbitrage involves moving money from one currency to another to a third