Suppose the Japanese yen exchange rate is 75 1 and the Brit

Suppose the Japanese yen exchange rate is ¥75 = $1, and the British pound exchange rate is £1 = $1.54.

a. What is the cross-rate in terms of yen per pound? (Round your answer to 2 decimal places, e.g., 32.16.)

Cross-rate ¥/£

b. Suppose the cross-rate is ¥120 = £1. What is the arbitrage profit per dollar used? (Do not round intermediate calculations and round your answer to 4 decimal places, e.g., 32.1616.)

Arbitrage profit $

Solution

a) $1 = yen 75 1 pound = $ 1.54 yen per pound Cross rate = 75*1.54 115.5 1 pound = Yen 115.50 b) If the cross rate is 1 pound = Yen 120 than the arbitrage profit would be The yen is quoted high relative to the pound. So,take out a loan for $1 and buy £0.6494(1/1.54) Use the pounds to purchase yen at the cross-rate, which will give you: £0.6494(¥120/£1) = ¥77.928 Use the pounds to buy back dollars and repay the loan. The cost to repay the loan will be: ¥77.928($1/¥75) = $1.03904 The arbitrage profit is $0.03904 per dollar used.