Class questions: September 30, 2014
Name_________________________
Lecture #11
ECON 4322-01
- Major topics to be covered in class on Thursday, October 2, 2014
o Gold standard continued
o Interwar period
o Bretton Woods

Reading coverage: Chapter 2
1. Suppose you observe the following quotes for Thai baht (in Vietnamese dong) in
Bangkok, for Czech koruna (in Vietnamese dong) in Ho Chi Minh City, and baht
(in Czech koruna) in Prague.
Bangkok: dong/baht 649.35062 – 656.89420
Ho Chi Minh City: dong/koruna 1038.6277 – 1041.6667
Prague: koruna/baht 0.5896 – 0.6076
a. Demonstrate that an arbitrage opportunity exists by selecting any two
markets and showing that the implied quote does not overlap the actual
quote in the third market.
Arbitrarily we select the first two markets. The implied koruna bid price
of the baht is:
649.35062 /1041.6667 = 0.6234
The implied koruna ask price of the baht is:
656.8942/1038.6277 = 0.6325
The actual price in Prague is too low. Ultimately, we want to buy baht
with koruna in Prague.
b. Suppose you start with Baht 154. Below, please show the total profit that
can be made by exploiting the arbitrage opportunity. You must show your
work.
To profit, we need to buy baht with koruna in the third market… So, we
need koruna. If we start with baht, we sell baht for Vietnamese dong, we
buy koruna with dong, and finally buy baht with koruna in Prague.
The result:
1. Baht 154*649.35062 = dong 999,999.9995
2. dong 999,999.9995/1041.6667 = koruna 96.0000
3. koruna 96.0000/0.6076 = baht 157.9987
Which, if exchanging cash, results in baht 158. Our profit is baht 4.
2.
Suppose you observe the following quotes for Thai baht (in Korean won) in
Bangkok, for yuan (in baht) in Shanghai, and yuan (in Korean won) in Seoul.
Bangkok: won/baht 30.9876 – 31.2500
Shanghai: baht/yuan 5.0325 – 5.0794
Seoul: won/yuan 163.9344 – 165.8678
a. Demonstrate that an arbitrage opportunity exists by selecting any two
markets and showing that the implied quote does not overlap the actual
quote in the third market.
Arbitrarily we select the first two markets. The implied won bid price of
the yuan is:
30.9876*5.0325 = 155.9451
The implied won ask price of the yuan
31.2500*5.0794 = 158.7313
b. Suppose you start with RMB 6.10. Below, please show the total profit
that can be made by exploiting the arbitrage opportunity. You must show
your work.
The price is Seoul is too high, so we want to see yuan there. We thus start
selling yuan in Seoul. The result:
1. 6.10 * 163.9344 = won 999.99984
2. won 999.99984/31.2500 = baht 32.00
3. baht 32.00/5.0794 = yuan 6.30
Our profit is yuan 0.20.
3. Suppose you observe for the following quotes for the euro (in RMB) in Shanghai, for
RMB (in pounds) in London, and euros (in pounds) in Paris.
Shanghai: RMB 8.7097 – 8.8125
London: Pound 0.0962 – 0.0999
Paris: Pound 0.7948 – 0.8065
a. Demonstrate that an arbitrage opportunity exists by selecting any two
markets and showing that the implied quote does not overlap the actual
quote in the third market.
Again, arbitrarily, we select the first two markets. The implied bid and
ask pound price of the euro is:
8.7097*0.0962 = Pound 0.8378
8.8125*0.0999 = Pound 0.8804
b. Suppose you start with RMB 10.40. Below, please show the total profit
that can be made by exploiting the arbitrage opportunity. You must show
your work.
The price in Paris is too low. Ultimately, we want to buy euros in Paris
with pounds. If we start with yuan, we sell them for pounds in London.
The result:
1. 10.40*0.0962 = pound 1.00048
2. 1.00048/0.8065 = euro 1.24052
3. 1.24052*8.7097 = RMB 10.80456
Of course, if we receive cash, we will receive RMB 10.80 resulting in a
profit of 0.40 RMB.
4. Suppose you observe for the following quotes for the Mexican peso (in US dollars) in
Mexico City, for dollars (in Korean won) in New York, and Mexican pesos (in Korean
won) in Seoul.
Mexico City: $0.0769 – 0.0798
New York: won 1099.9982 – 1136.8952
Seoul: won 75.9042 – 76.9230
a. Demonstrate that an arbitrage opportunity exists by selecting any two
markets and showing that the implied quote does not overlap the actual
quote in the third market.
Again, arbitrarily, we select the first two markets. The implied bid and
ask won price of the peso is:
0.0769*1099.9982 = won 84.5899
0.0798*1136.8952 = won 90.7242
b. Suppose you start with won 1000. Below, please show the total profit that
can be made by exploiting the arbitrage opportunity. You must show your
work.
The price is Korea is too low. Ultimately, we want to buy pesos using
won. The result:
1. 1000/76.9230 = peso 13.000013
2. 13.000013*0.0769 = $0.999701
3. 0.999701*1099.9982 = won 1099.67
The smallest denomination of the Korean won is a 10-won coin (worth less
than a penny). As such, if this transaction were being settled for cash, it
would settle for won 1100. Our total profit is won 100.