£1 = Rs 77.1125 in London
$1 US = $1.6231 in New York
Are any arbitrage gains possible? Assume there are no transaction costs and the arbitrageur has US $1,000,000.
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Solution:
Arbitrage gains are possible since the cross rate between US $/British £ by using the rates at London and at Mumbai is different (Rs 77.1125/Rs 48.3011 = US $1.5965/£1) from that of New York ($1.6231). The arbitrageur can adopt the following steps to realize arbitrage gain.
- The arbitrageur will buy Indian rupees with US $1 million. The total proceeds he obtains is (Rs 48.3011 x $1 million US $) Rs 48,301,100.
- He converts Indian rupees in British £ at the London forex market. He receives (Rs 48,301,100/ Rs 77.1125) £626,371.8592.
- He then converts £626,371.8592 at the New York forex market. He obtains (£626,371.8592 x $1.6231) US $1,016,664.164
- Thus, he has net gain of (US $1,016,664.164 – $1,000,000) US $16,664.164.
