Question

11. What arbitrage opportunity exists with the following quotes? How much profit could be made by starting amount of AUD 1,000,000? Bank A: AUD/USD = 0.8520 – 0.8525 Bank B: AUD/USD = 0.8526 – 0.8531

Answer 1

Let us first understand the quotes given to us:

• Bank A: AUD/USD = 0.8520 – 0.8525
  • Here, AUD is the price currency and USD is the base currency
  • The quotes above are given from the dealer's perspective, dealer is the bank
  • 0.8520 is the bid or the rate at which bank A will buy 1 unit of USD and give AUD 0.8520 in return
  • 0.8525 is the ask or the rate at which bank A will sell 1 unit of USD and receive AUD 0.8525 in return
• Bank B: AUD/USD = 0.8526 – 0.8531
  • Here, AUD is the price currency and USD is the base currency
  • The quotes above are given from the dealer's perspective, dealer is the bank
  • 0.8526 is the bid or the rate at which bank A will buy 1 unit of USD and give AUD 0.8526 in return
  • 0.8531 is the ask or the rate at which bank A will sell 1 unit of USD and receive AUD 0.8531 in return

Now let us calculate the arbitrage profit:

• We have AUD 1,000,000
• We sell the same to Bank A.
• This implies that bank A will buy AUD and sell USD
• Therefore we need to look at the ask rate of bank A which is 0.8525
• If 0.8525 AUD = 1 USD then 1000000 AUD = 1000000/0.825 USD = USD 1173020.528
• Next we sell these USD to Bank B and get AUD in return
• Here, bank B will buy USD and sell AUD so we will look at the bid rate of Bank B which is 0.8526
• So if USD 1 = AUD 0.8526 then USD 1173020.528 = AUD 1173020.528 x 0.8526 = AUD 1000117.302
• So the profit will be AUD 1000117.302 - AUD 1,000,000 = AUD 117.302