2 Arbitrage involving three currencies According to our lectures, arbitrage is an operation by which an investor buys a given currency if it is cheap, or sells it if it is expensive. To deepen our understanding of this crucial equilibrating force, in this exercise we work on triangular arbitrage. According to it, the no-arbitrage condition for transactions involving three currencies (e.g., pound sterling, euro and dollar) is as follows: Er/s = EnjeEels = Esje direct rate cross rate When this condition is satisfied, there is no profit opportunity left in the market. While thinking of the answer to this whole problem, you may want to watch a broader and more general discussion on this topic from Gita Gopinath (Deputy Managing Director of the IMF, on leave from her position as Professor at Harvard): https://voxeu. org/content/ dominance-us-dollar-trade-and-finance. Figure 13: Dollar and Euro Shares of Cross-Border Corporate Bond Positions 08 03 2005q3 2008q1 2010q3 2013q1 2015q3 USD ---- EUR Note: Figure plots the share of dollar and euro denominated corporate bonds in total cross-border holdings. Figure 1: Source: Maggiori, Neiman and Schreger (2018, NBER). Refer to "Table 14-1: Exchange rate quotations" from the main textbook, a copy of which is available on ADI. It reports exchange rates not only against the U.S. dollar, but also against the euro and the pound sterling. (Each row gives the price of the dollar, euro, and pound, respectively, in terms of a different currency.) At the same time, the table gives the spot dollar prices of the euro ($1.1219 per euro) and the pound sterling ($1.2597 per pound). Pick, for instance, China, Mexico and South Africa from the table and show that the three quoted spot exchange rates (in terms of dollars, euros, and pounds) "approximately" rule out triangular arbitrage. What could justify an "approximation" if it is needed