FIN 4180 – International Financial Management

Summer 2018

Assignment 3 – Arbitrage

Due: February 3, 2018

Do this assignment individually.

The following are quotes for several U.S. currency dealers.

Dealer

A

B

C

D

E

Japanese yen

108.98 – 109.00

109.02 – 109.06

108.99 – 109.02

109.01 – 109.05

108.97 – 109.01

British pounds

1.2374 – 1.2376

1.2376 – 1.2378

1.2378 – 1.2381

1.2376 – 1.2378

1.2373 – 1.2375

Inter-dealer arbitrage

1a. Is there an arbitrage opportunity in Japanese yen? If so, what exchanges should you make to take advantage of it? (Be specific about which dealer you would select, what currency you would buy from or sell to that dealer, and how much of the other currency you would pay or receive.

b. How profitable is a round trip trade? (State the profitability either in percent or basis points.)

2a. Is there an arbitrage opportunity in British pounds? If so, what exchanges should you make to take advantage of it? (Be specific as indicated in question 1.)

b. How profitable is a round trip trade? (State the profitability either in percent or basis points.)

Triangular arbitrage (Inter-market) – assume that the highest bid and lowest ask for each currency are equal (so that the bid-ask spread is zero)

3. The New York spot exchange rate for Canadian dollar (USD/CAD) is 1.2336 and the spot exchange rate for the Mexican peso (USD/MXN) is 18.6343. What must the spot exchange rate for the peso in Toronto (CAD/MXN) be if no arbitrage opportunity exists?

4a. Using the New York market spot exchange rates from the previous questions, if, in Toronto, the exchange rate for the peso is 15.0965, what trades should you make to take advantage of the arbitrage opportunity? For each transaction, be specific about where the trade takes place, which currency you would purchase (or sell) and which currency you would use to pay (or receive)

b. How profitable is a round trip trade? State the profitability either in percent or basis points.

5a. The San Francisco spot exchange rate for the New Zealand dollar (NZD/USD) is 0.7318 and the spot exchange rate for the Malaysian ringgit (USD/MYR) is 3.8840. What must the spot exchange rate for the ringgit in Wellington (NZD/MYR) be if no arbitrage opportunity exists?

6a. Using the San Francisco market spot exchange rates from the previous questions, if, in Wellington, the exchange rate for the ringgit is 2.8432, what trades should you make to take advantage of the arbitrage opportunity? For each transaction, be specific about where the trade takes place, which currency you would purchase (or sell) and which currency you would use to pay (or receive)

b. How profitable is a round trip trade? State the profitability either in percent or basis points.

7a. The New York spot exchange rate for the euro (EUR/ USD) is 1.2380 and the spot exchange rate for the Australian dollar (AUD/USD) is 0.8094. What must the spot exchange rate for the Australian dollar in Frankfurt (EUR/AUD) be if no arbitrage opportunity exists?

8a. Using the New York market spot exchange rates from the previous questions, if, in Frankfurt, the exchange rate for the Australian dollar is 1.5289, what trades should you make to take advantage of the arbitrage opportunity? For each transaction, be specific about where the trade takes place, which currency you would purchase (or sell) and which currency you would use to pay (or receive)

b. How profitable is a round trip trade? State the profitability either in percent or basis points.

Covered interest arbitrage (Inter-temporal) – assume that the highest bid and lowest ask are equal (i.e., that the bid-ask spread is zero)

9. Assume the interest rate of 1-year risk free debt denominated in US dollars is 1.72% and the interest rate on 1-year risk free debt denominated in Colombian pesos is 4.75%. If the spot market exchange rate for the Colombian peso (USD/COP) is 2844.36, what is the 1-year forward exchange rate if interest rate parity holds?

10a. If the actual 1-year forward exchange rate for Colombian pesos is 2931.99 and the spot market exchange rate and interest rates are as indicated in question 9, what trades should you make to take advantage of the arbitrage opportunity? Be specific about both current and future transactions (i.e., be sure to specify what currency/currencies are involved and how, and the amount of each – you can make any assumption you like about the amount of currency to start).

b. How profitable is the trade? (State the profitability, either in dollars or pesos and as a percent of initial amount borrowed.)

11. Assume the interest rate on 6-month risk free debt denominated in US dollars is 1.57%, the interest rate on 6-month risk free debt denominated in Namibian dollars is 6.75%. If the spot market exchange rate for the Namibian dollar (USD/NAD) is 11.9800, what must the 6-month forward rate on the Namibian dollar be if interest rate parity holds?

12a. If the 6-month forward exchange rate for the Namibian dollar 12.2777 and the spot market exchange rate and interest rates are as indicated in question 11, what trades should you make to take advantage of the arbitrage opportunity? Be specific about both current and future transactions (i.e., be sure to specify what currency/currencies are involved and how, and the amount of each – you can make any assumption you like about the amount of currency to start).