Question 21.2: Shedding Some Pounds Suppose the exchange rates for the Br...

Fundamentals of Corporate Finance Standard Edition

Shedding Some Pounds

Suppose the exchange rates for the British pound and Swiss franc are:

Pounds per $1 = .60

SF per $1 = 2.00

The cross-rate is three francs per pound. Is this consistent? Explain how to make some money.

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The cross-rate should be SF 2.00/£.60 = SF 3.33 per pound. You can buy a pound for SF 3 in one market, and you can sell a pound for SF 3.33 in another. So, we want to first get some francs, then use the francs to buy some pounds, and then sell the pounds. Assuming you have $100, you could:

1. Exchange dollars for francs: $100 × 2 = SF 200.

2. Exchange francs for pounds: SF 200/3 = £66.67.

3. Exchange pounds for dollars: £66.67/.60 = $111.12.

This would result in an $11.12 round-trip profit.

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