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CFA Level I · CFA Level I Exam · Exchange Rate Calculations

If a dealer's quoted cross rate differs from the rate implied by two other exchange rates, which outcome is most likely as arbitrageurs act on the discrepancy?

The quoted cross rate will most likely move toward the implied cross rate. Arbitrageurs buy the underpriced currency and sell the overpriced one until the riskless profit disappears, restoring consistency among the three exchange rates.

  1. AThe quoted cross rate moves toward the implied cross rateCorrect
  2. BThe implied cross rate moves permanently away from the quoted rate
  3. CInterest rates in both countries rise by the amount of the discrepancy

Explanation

Triangular arbitrage trades push prices until no riskless profit remains, so the quoted and implied crosses converge. Nothing in the process forces interest rates to change.

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