Author Question: Suppose in Zurich / = 0.5, while in New York SF/ = 2.5, but in London /SF = 0.1. (a) Is there any ... (Read 33 times)

ericka1 · **on:** Jun 30, 2018

Suppose in Zurich / = 0.5, while in New York SF/ = 2.5, but in London /SF = 0.1.

(a) Is there any arbitrage profit that could be made with a triangular arbitrage action? Describe an example of how such a profit may be earned.
(b) What would you guess about the relationship between the dollar rates and cross-rates after arbitrageurs notice this profit opportunity?

Question 2

What would be the effect of an increase in the European Money Supply in the Dollar Euro Exchange Rate?

What will be an ideal response?

lgoldst9 · **Reply #1 on:** Jun 30, 2018

Answer to Question 1

(a) Buy SF 1 million in London for 190,000
Use it to buy in New York, so that SF 1m = 400,000.
Buy pounds in Zurich so that 400,000 = 200,000
200,000 - 190,000 = 10,000 profit
(b) We expect the gap between rates to close as arbitrageurs buy pounds in Zurich and sell in London through the New York market, i.e., the relationship between rates is restored where cross-rates yield no potential profit.

Answer to Question 2

An increase in the European money supply lowers the dollar return on Euro deposits, i.e. the dollar appreciates against the Euro. There is no change in the US money market.