ExampleExchange Arbitrage

1
Example Exchange Arbitrage

• You have access to the following three spot
  exchange rates 0.01/yen, 0.20/krone,
  25yen/krone. You start with dollars and want to
  end up with dollars.
• A) How would you engage in arbitrage to profit
  from these three rates? What is the profit for
  each dollar used initially?
• B) As a result of this arbitrage, what is the
  pressure on the cross-rate between yen and krone?
  What must the value of the cross-rate be to
  eliminate the opportunity for triangular
  arbitrage?

2
Solution

• A) dollars ----gt krone ----gt yen ----gt dollars
• 1 / 0.2 25 0.01 1.25
• Profit 0.25
• B) Selling krone to buy yen puts downward
  pressure on the cross rate (the yen price of
  krone). The value of the cross rate must fall to
  20yen/krone to eliminate the opportunity for
  triangular arbitrage.