Question

1. (15 points) Triangular Arbitrage w/ bid-ask spreads Continue to assume that you are a large money center bank and you have 3,000,000 South Korean Won. The following banks make the following quotes:

Bank	Location of Bank	Exchange rate quotes
Bank BNP Paribas	Paris, France	137.1472 yen/euro 137.1463 yen/euro
The Bank of Tokyo - Mitsubishi UFJ	Tokyo, Japan	10.1251 won/yen 10.1247 won/yen
Korea Exchange Bank	Seoul, Korea	1386.57 won/euro 1386.42 won/euro

Determine a way to make a profit. Using complete sentences, describe the actions you would take to make this profit, stating the amounts of currency you would exchange in each step and through what institution you make that exchange. Also, clearly state the profit you make and be clear what currency that profit is in.

Answer 1

We have 3,000,000 won at the beginning

Now, we will visit Korea Exchange Bank and exchange 3,000,000 won for euro

The exchange rate used will be the bid rate i.e. 1386.57 won/euro as we are buying the base currency

Thus, we will receive (3,000,000/1386.57) = 2163.6124 euros

Now, we will visit Bank BNP Paribas and convert the euro into yen

We will use ask rate i.e. 137.1463 yen/euro for this transaction as we are selling the base currency

Thus, we will receive (2163.6124 * 137.1463) = 296,731.4308 yens

Now, we will visit The Bank of Tokyo and exchange the yens for won at the ask rate i.e 10.1247 won/yen as we are selling the base currency

So we will receive, (296,731.4308 * 10.1247) = 3,004,316.7174 won

Thus, we ended up with 3,004,316.7174 won which means we made a profit of 3,004,316.7174 - 3,000,000 won = 4,316.7174 wons