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Lane
Lane, JD, CFP, MBA, CRPS
Category: Finance
Satisfied Customers: 3904
Experience:  Providing Financial, Tax & Business advice since 1986
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Why is trianular arbitrage not feasible

Resolved Question:

Why is trianular arbitrage not feasible
Submitted: 9 months ago.
Category: Finance
Expert:  Lane replied 9 months ago.

Lane :

Hi,

Lane :

Maily because opportunities only exist very rarely ... and when they do, go away in a matter of seconds as the rates correct

Lane :

You do this by converting one currency to another, converting it again to a third currency and, finally, converting it back to the original currency within a short time span. This opportunity for riskless profit arises when the currency's exchange rates do not exactly match up.

Lane :

These opportunities do not happen very often and when they do, they only last for a matter of seconds.

Lane :

People that use this type of arbitrage would have t have have advanced computer equipment and/or programs to automate the process, and even then woud have continually to update assumptions as the environment changes

Customer:

How does arbitrage conducted to make a profit? When it happens in seconds do people use spot rates to grab those moment before change?

Lane :

Here's a great example from investo pedia: Note tha amount of money needed to make a little over $1,000, andlo noe that in this example, NO trading costs are subtracted .. NOT are taxes:

Lane :

Sell dollars for euros: $1 million x 0.8631 = 863,100 euros
Sell euros for pounds: 863,100/1.4600 = 591,164.40 pounds
Sell pounds for dollars: 591,164.40 x 1.6939 = $1,001,373 dollars

$1,001,373 - $1,000,000 = $1,373

Customer:

What does .8631 represent?

Lane :

tiny profit, very rare, and havge tp be watching continuously

Lane :

the exchange rate

Customer:

from dollar to euro

Lane :

right

Lane :

first

Customer:

So triangular arbitrage is feasible, but only for seconds when it is watched continously and it only occurs for seconds

Customer:

Can spot rates assist when identifying trangular arbitrage?

Lane :

The peer reviewed work that has been done, says that when you factor in the cost of the equipment, and intellectual property (software), cost of capital t make those huge trades happen (trading costs. borrowing costs and taxes) it become unfeasible .. more cost that revenue (no profit) a waste of time

Lane :

You are using spot rates already

Customer:

Okay thank you.

Lane :

eg, how much did that $1,000,000,000 trade ost ... even if you had the cash ... You're very welcome

Customer:

how does someon dteriimen the interes arbitrage? like in your example? Do you always use an amount and divide by the currency?

Lane :

If this has helped, I would appreciate a feedback rating of 3 (OK) or better (excellent, is ideal)… That's the only I get credit for the work.


However, if you need more on this, please come back here, so you won't be charged for another question.


Customer:

Oh of course

Customer:

I need to know how to determine whether covered interest arbitrage is feasible and how it should be conducted to a make a profit

Customer:

If I submit the service rating it indicates that it will close out the chat

Customer:

Are you able to assist with the how to determine interest arbitrage?

Lane :

on yur last question, remember, all you're doing is converting from one currency to another, in that millisecond when exchange rates don't life up (and in thodays world, qhere that all controlled by systems (computers) that in itself is effectively impossible .. basically today you're looking for places where the exchange rates are wrong

Customer:

I guess I dont understand the question in the book becaue if it is not profitable, I am not sure how I am suppose to calculate the it to make a profit.

Lane :

As I have explained ... it is not ... the way you you determine it is to write the formulas for calculating all the possibilities where the exchange rates (has nothing to do with interest) are out of whack for some reason, and then to effect all three trades, essentially instantly. Then once you do that (IF the possibility even exists any more) once you pay the costs of doing it you're stll at a loss

Lane :

TH book probably taking the real world costs off the table

Customer:

sorry, yes exchange is different than the interest rates... I am messed up on that. :(

Customer:

The questions reads, using the information in the question 1 determine whether covered interest arbitrage is fesible and if so, how it should be conducted to make a profit

Customer:

If it is not possible, then how can it make a profit?

Customer:

How do I use a table to determine if it is possible, when really it is not very possible.

Lane :

Again, they are not factoring in the (1) the costs of margin, (2) trading costs, and (3) the fact that is is a short tem gain, so taxes at ordinary income tax rates

Lane :

(I did not know) that this was a homework problem ... not really supposed to answer those in this are

Lane :

area

Customer:

I am working on a table

Customer:

Thanks

Lane, JD, CFP, MBA, CRPS
Category: Finance
Satisfied Customers: 3904
Experience: Providing Financial, Tax & Business advice since 1986
Lane and 3 other Finance Specialists are ready to help you

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