Triangular Arbitrage Problem
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Assume the following information
Value of Canadian dollar in U.S. dollars $.90
Value of New Zealand dollar in U.S. dollars $.30
Value of Canadian dollar in New Zealand dollars NZ$3.02
Given this information , is triangular arbitrage possible? If so, explain the steps that would relect triangular arbitrage, and compute the profit from this strategy if you had $1,000,000 to use.
What market forces would occur to eliminate any further possibilities of triangular arbitrage?
Please show work, I can't seem to grasp this.
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Solution Summary
This posting gives a detailed solution to a triangular arbitrage problem. It explains when triangular arbitrage is possible and the step by step process of computing profit given three different cross exchange rates. It also explains the market forces which would occur to eliminate any further possibilities of triangular arbitrage.
Solution Preview
Given the three foreign exchange rates among the Canadian dollar, the U.S. dollar, and the New Zealand Dollar. Triangular arbitrage will produce a profit whenever the following relation does not hold:
CAD/USD x NZD/CAD = NZD/USD
As per the assumed information-
Value of Canadian dollar in U.S. dollars $.90 i.e. 1 USD = 1/0.90 CAD = CAD 1.11
Value of New Zealand dollar in U.S. dollars $.30 i.e. 1 USD = 1/0.30 NZD = NZD 3.33
Value of Canadian dollar in New Zealand dollars NZ$3.02
Hence,
? the Canadian Dollar (CAD) and the US dollar ...
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