Page 4 - FINAL CFA II SLIDES JUNE 2019 DAY 4

LOS 11.b: Identify a triangular arbitrage opportunity and
calculate its profit, given the bid–offer quotations for three READING 11: CURRENCY EXCHANGE RATES: UNDERSTANDING EQUILIBRIUM VALUE
currencies.
MODULE 11.1: FOREX QUOTES, SPREADS, AND TRIANGULAR
ARBITRAGE
CROSS RATE: Exchange Suppose USD/AUD = 0.60
rate between two currencies and MXN/USD = 10.70. CROSS RATES WITH BID-ASK SPREADS
implied by their exchange What is the cross rate Bid-ask spreads complicate the calculation of cross rates.
rates with a common third between Australian dollars Given 3 currencies A, B, and C, we could have:
currency (used when there and pesos (MXN/AUD)?
is no active foreign
exchange (FX) market in
the currency pair being
considered).

TRIANGULAR ARBITRAGE

A clock wise (and later, counterclockwise) currency trading process (checking for arbitrage opportunities) in which we begin with
3 pairs of currencies (each with bid and ask quotes) and construct a triangle where each node represents one currency.

EXAMPLE: Triangular arbitrage
The following quotes are available from the
interbank market:

Quotes: Ask USD Bid USD
USD/AUD 0.6000 – 0.6015
USD/MXN 0.0933 – 0.0935

1. Compute the implied MXN/AUD cross rate. MXN/AUD Bid for AUD Offer for AUD SPREAD
2. If your dealer quotes MXN/AUD = 6.3000 –
6.3025, is an arbitrage profit possible?
3. If so, compute the arbitrage profit in USD if Dealer Quoted Rates 6.3000 - 6.3025 0.0025 MXN per AUD
you start with USD 1 million.
Cross Rates 6.4200 - 6.4481 0.0281 MXN per AUD

Results mean? Re Q2? Both not equal, so arbitrage profit must exist!

Q3) Try triangular arbitrate -using dealer rates, not cross rates! Why?