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Session 14 - 16 Triangluar Abritrage
Session 14 - 16 Triangluar Abritrage
ARBITRAGE
WHAT IS TRIANGULAR ARBITRAGE
CONT..
• To ensure profits, such trades should be performed quickly and should be large in size.
• The trader would exchange an amount at one rate (EUR/USD), convert it again
(EUR/GBP) and then convert it finally back to the original (USD/GBP), and assuming
low transaction costs to net a profit.
EMPIRICAL EVIDENCE
• A study examining exchange rate data provided by HSBC Bank for the Japanese
yen (JPY) and the Swiss franc (CHF) found that although a limited number of arbitrage
opportunities appeared to exist for as many as 100 seconds, 95% of them lasted for 5
seconds or less, and 60% lasted for 1 second or less.
• Further, most arbitrage opportunities were found to have small magnitudes, with 94% of
JPY and CHF opportunities existing at a difference of 1 basis point, which translates into
a potential arbitrage profit of $100 USD per $1 million USD transacted.
The Process Of Completing A Triangular Arbitrage Strategy
With Three Currencies Involves Several Steps:
3. If a difference in the rates from step 2 is present then, trade the base currency for a second currency
4. Then trade second currency for a third. At this stage, the trader is able to lock in a no-risk profit due to
the imbalance that exists in the rates across the three pairs,
5. Converting the third currency back into the initial currency to take a profit.
PROBLEM 1 WHERE INFORMATION IN GIVEN IN ONE WAY QUOTE
AS AN EXAMPLE, SUPPOSE YOU HAVE $1 MILLION AND YOU ARE PROVIDED WITH THE
FOLLOWING EXCHANGE RATES: EUR/USD = 0.8631, EUR/GBP = 1.4600 AND USD/GBP = 1.6939.
• The arbitrager has US $ 100,00,000. Assuming that there are no transaction cost. Explain
whether there is any arbitrage gain from the quoted spot exchange rates.
• USD= INR 48.30 (Mumbai ------------------------------INR /$= 48.30
• GBP= INR 77.52 (London) ------------------------------INR/GB
• This quote is US.
• GBP= USD = 1.6231 (New York ---------------------USD/GBP ---- Sell
i.e, $ is the home
currency.
• When ever the quotations are given in direct quote. In case the INR, the final result
should be in INR
Arbitrage Process
Step 1 Sell $ 1 Cr in Mumbai @ 48.30 = RS. 48.30 * 100,00,000 = Rs 48,30,00,000
Step 2
RS/ USD
3. Finally, the trader converts the euros into the initial currency, i.e., JPY, to
cash profits = € 504 / 0.0068 = JPY 74,117.6470
4. Thereby, the Japanese trader will earn profits worth JPY 24,117.647 through
triangular arbitrage on an initial investment worth JPY 50,000.
Problem 5. From following 3 quotes, examine if any arbitrage gains are possible, if the
arbitrager has SGD 1 million
In The New York Market, The Following Price Of EURO Is Quoted As Follows
$/€ = 1.2500 – 1.2600
IN LONDON, THE VALUES OF US DOLLAR AND EURO AGAINST BRITISH POUND ARE
AS FOLLOWS
$/£ = £1.5650 -----£1.5750
€/£ = 1.2200 ---- 1.2300
a) Formula Bid *
=1.5650*1/1.2300 = 1.2724
b) Formula
= 1.2910
The exchange rate in New York and London are therefore as follows