3. Three forms of arbitrage

a. Assume the following information for New Zealand dollar.

Bank

Bid

Ask

Under/Overvalued?

Market forces

Fargo Bank

0.41

0.42

Moorhead Bank

0.39

0.40

Is locational arbitrage possible? If so, explain the steps involved in locational arbitrage and compute the profit from this arbitrage if you had $1,000 to use. What market forces would occur to eliminate any further possibilities of locational arbitrage?

b. Assume the following information:

Rate

Bid

Ask

Under/Overvalued?

Market forces

EUR/USD (direct)

1.20

1.25

USD/YEN (indirect)

110

115

EUR/YEN

150

152

Make sure you notice the indirect rate. Is triangular arbitrage possible? If so, explain the steps involved in triangular arbitrage and compute the profit from this arbitrage if you had $100,000 to use. What market forces would occur to eliminate any further possibilities of triangular arbitrage?

c. Assume the following information:

Rate

Market forces

Spot Rate of Canadian dollar (CAD)

$0.85

1 year forward rate of CAD

0.82

1-year Canadian interest rate

5%

1-year U.S. interest rate

2%

Is covered interest arbitrage possible? If so, explain the steps involved in the arbitrage and compute the profit from this arbitrage if you had 100,000 USD or 200,000 CAD to use. What market forces would occur to eliminate any further possibilities of triangular arbitrage?