Author Question: What is arbitrage? Assume that the dollar is quoted 1 = 0.625 in New York and the pound sterling is ... (Read 97 times)

cdr_15 · **on:** Jul 10, 2018

What is arbitrage? Assume that the dollar is quoted 1 = 0.625 in New York and the pound sterling is quoted as
1 = 1.63 in London.

Is there an arbitrage opportunity? If so, what would an astute trader do? What will
happen to the quotes as trades are made at current prices?

Question 2

The future value of a combination of positive and negative cash flows cannot be determined.

Indicate whether the statement is true or false.

irishcancer18 · **Reply #1 on:** Jul 10, 2018

Answer to Question 1

Arbitrage is the simultaneous purchase and sale of an asset in more than one market resulting in a riskless profit. There
is an arbitrage opportunity because the price of a pound in New York is 1.60 and the price of a pound in London is
1.63. Given the current quotes, an astute investor will buy pounds in New York while simultaneously buying dollars
in London. Example: A 10,000 investment in New York will buy 6,256 (10,000 0.6256). Simultaneously buying
dollars in London yields 10,197.28 (6,256 1.63), a 1.65 gain. Since the transactions are entered simultaneously, no
risk is involved. The sale of dollars in New York for pounds and the sale of pounds in London for dollars will force the
rates back to equilibrium.

Answer to Question 2

Answer: FALSE
Explanation: The future value of a combination of positive and negative cash flows can be determined.