If the direct euro price of the British pound is higher than the indirect euro price of the British pound using the dollar as a vehicle currency, how could you make a profit by trading these currencies?
What will be an ideal response?
If the direct euro price of the British pound is higher than the indirect euro price of the British pound using the dollar as a vehicle currency, there would be a triangular arbitrage. We would want to buy pounds at the indirect low price and sell pounds at the direct high price. Suppose in Question 7 that the direct price euros per pound were €1.2115/£ and the exchange rates versus the dollar are €0.7636/$ and $1.5477/£. The indirect euro price of the pound is therefore
If we start with €10,000,000, we can convert euros to dollars and get
€10,000,000 / €0.7636/$ = $13,095,862
Converting these dollars into pounds gives
$13,095,862 / $1.5477/£ = £8,461,499
Converting these pounds into euros gives
€1.2115/£ £8,461,499 = €10,251,106
Thus, we make a profit of €251,106 or 2.51%.
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