1. The following exchange rates are given:

USD 1	=	AUD 1.33
USD 1	=	GBP 0.56
AUD 1	=	GBP 0.41

An Australian investor is looking for an arbitrage opportunity. Assuming this investor has AUD 400 available (and cannot borrow additional funds) calculate the amount of profit that can be made. Give your answer in Australian dollars and cents to the nearest cent.

Profit =

2. Before the collapse of Barings Bank in 1995 executives were thrilled when Nick Leeson announced huge arbitrage profits in trading between Singapore markets and Japanese markets. The executives even considered switching the focus of the entire bank to arbitrage. Why were the executives incredibly ignorant in not recognising a problem?

	arbitrage cannot generate any profit because it has zero risk
	arbitraging between two countries will not generate a profit because of the balancing effect of foreign exchange
	arbitrage is risky so profits cannot continue indefinitely
	arbitrage can never be substantially profitable because it has zero risk

[2  marks]

3. select a or b on the statements below giving the appropriate definition of each statement about currency trading:

To take a speculative position in a currency means: (a.) to use a trade to secure a risk free profit (b) to use a trade to deliberately create risk.

To take an arbitrage opportunity in a currency means: (a.) to use a trade to secure a risk free profit (b)to use a trade to deliberately create risk.

4. According to the law of one price:

	two bonds with the same coupon rate must have the same price
	a bond must have a single price in an efficient market
	the price of a bond does not change between the date of purchase and maturity
	the price of a bond is independent of the coupon rate

Answer rating: 100% (QA)

Question 1 The Australian investor can exploit the arbitrage opportunity by buying British pounds GBP with Australian dollars AUD and then selling the ... View the full answer