Homework 1 on Triangular Arbitrage with Bid-Ask Spread
S (€ / £) = S ($ / £) / S ( $ / €)
Suppose
Citibank’s quote: $1.5445 – 1.5460 / €
Barclay’s quote: $1.9443 – 1.9453 / £
Dresdner’s quote: €1.2789 – 1.2799 / £
Cross-rate between Citibank and Barclay should be € 1.2589 / £, compared to the actual Dresdner quote of €1.2789 / £.
Is triangular arbitrage possible if an investor starts with € 1 million and follows the following two strategies independently?
(a) Euros to Dollars to Pounds to Euros.
(b) Euros to Pounds to Dollars to Euros.
If there are arbitrage gains or losses in either case, how much?