Solutions:

1. If we start with 1 million USD and move clockwise around the triangle (USD to GBP to
EUR to USD), we first convert 1 million USD into GBP at the ask:
Then we sell the GBP for EUR at the bid:
Finally, we purchase USD at the ask in euros:
Arbitrage profits are 1,006,372 USD – 1,000,000 USD = 6,372 USD.

2. The current spot exchange rate: $1 = €0.74.

Europe US
Nominal 1 year 4% ?
Interest
Expected inflation 2% 1%

a) r = real r + E(I)
From European data:
4% = real r + 2%

real r = 2%
For United States: r = 2% + 1%
r = 3%

b) The current spot rate is $(1/0.74) per Euro or $1.3513/€

Expected exchange rate in 1 year = 1.3513(0.99) = $1.3378/€

c) F=So X (1+Rs)/(1+R)=(1/0.74)x((1.035/1.04) = 1.3449$ per Euro

3. 46,100$
4. Buy 1 Euro at 1.50$, buy 1 pound at 1.25 Euro, and sell pound for 2$.
5. a. Spot is C$ 1.0072/DM = (1.40 [C$/$] / 1.39 [DM/$])
b. Arbitrage opportunity: DM cheaper with combination of direct rates than using
the cross rate.
c. BuyUS$withC$at1.40,buy DM with US$, sell DM at the market's cross rate of C$
1.05/DM.
d. Gain is C$ 0.0425 for each C$ 1.0 that can be arbitraged
or 4.25% [(1/C$1.4/$) * DM1.39/$ * C$1.05/DM = C$1.0425; 1.0425 - 1 = 0.0425]