Answer:
(a) Yes, there is a profit by making triangular arbitrage action. Profit starting with selling ¥1,000,000 in London will be ¥250,000. Detailed description is in explanation part.
(b)
The dollar-pound exchange rate will change in the way that pound will be depreciated because there is more supply of pound in New York market following a arbitrageur action as they notice the profit-making opportunity.
Cross rates after arbitrageurs notice will be adjusted to the point where there is no arbitrage opportunity occurs. In (a) example, keeping other exchange rate unchanged, the dollar-pound exchange rate will be adjusted to £/$ = 1.25.
Explanation:
(a)
Investor sell ¥1,000,000 in London to get £500,000 ( exchange rate £/¥ = 0.50).
Further, he sells these £500,000 in New York to get $500,000 ( exchange rate £/$=2.5)
Next, they sell $500,000 to get ¥1,250,000 in Tokyo ( exchange rate ¥/$=2.5)
=> Net profit is ¥1,250,000 - ¥1,000,000 = ¥250,000
(b)
Details have already been explained in the answer part.
