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You observe the exchange rates from the following 4 currencies(US, EU, UK, and Japan): a.$1.19/€, $1.30/£, $0.0091/¥ b.€0.84/$,...

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Finance

You observe the exchange rates from the following 4currencies(US, EU, UK, and Japan):

a.$1.19/€, $1.30/£, $0.0091/¥

b.€0.84/$, €1.09/£, €0.0076/¥

c.£0.77/$, £.91/€, £0.0055/¥

d.¥110.27/$, ¥130.77/¥, 183.26/£

Suppose that you incur 2% transaction costs. That is, if youattempt to convert one currency to another, you only get 98% of thequoted rate. So with €1, you can get .98*$1.19 = $1.17 There is anarbitrage opportunity in this market. Find it and describe eachtransaction you would take to exploit it. If a large amount ofmoney went through this process, this would exert pressure on theseexchange rates. For each transaction in your arbitrage strategy,explain how that transaction would impact currency values.

Answer & Explanation Solved by verified expert
3.8 Ratings (320 Votes)

Data Provided
Currency $ Pound Euro Yen
$            1.000000            0.840000            0.770000        110.270000
Pound            1.190000            1.000000            0.910000        130.770000
Euro            1.300000            1.090000            1.000000        183.260000
Yen            0.009100            0.007600            0.005500            1.000000
Solution
Convertion of Pound to $ Conversion of $ to Euro Conversion of $ to Yen
Convertion of $ to Pound              0.84034              0.76471          109.89076
Conversion of $ to Euro              0.83846              0.76923          140.96923
Conversion of $ to Yen              0.83516              0.60440          109.89011
As can be seen from the highlighted yellow tables above - Conversion of $ to Yen via converting $ to Euro is beneficial
Conversion of Dollar to Eurio            0.769231
Less : Transaction Cost @ 2%            0.015385
Euro available after converting $ to Euro            0.753846
Convert avaiable Euro to Yen        137.062937
If Dollar Directly Converty to Yen (After Transaction Cost of 2%)        108.064600
Benefit of Yen          28.998337
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