Question

Assume the following information:

                                                                                                       Quoted Price

      Value of GBP in U.S. dollars                                                          $1.40

      Value of Australian dollar in U.S. dollars                                         $.80

      Value of GBP in Australian dollars                                           AU$1.78

      Is triangular arbitrage possible?

      If so, how much you can benefit from this strategy if you had $1,000,000 to use. What market forces would occur to eliminate any further possibilities of triangular arbitrage?

Answer 1

1GBP = We follow the following steps to get arbitrage profits:

• Sell $ 1000000 for GBP
  • GBP 1 = $1.4
  • So $1000000 = GBP 1000000/1.4 = 714285.7143
• Sell GBP for AUD
  • 1GBP = AUD 1.78
  • So GBP 714285.7143 = 714285.7143 x 1.78 = AUD = 1271428.571
• Sell AUD for USD
  • AUD 1 = USD 0.80
  • So AUD 1271428.571 = 1271428.571 x 0.80 = USD 1017142.857
• So we started with 1000000 and ended up with 1017142.857 which is a profit of USD 171142.86
• As more and more people start gaining from it, the demand for GBP and AUD will increase, driving up their rates in terms of other currencies and that would lead to elimination of such profit.