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

Which of the following statements best describes the effect of triangular arbitrage on the quoted exchange rates when a cross rate is mispriced?

Arbitrage trades push quotes back toward consistency with the implied cross rate. Buying the undervalued currency and selling the overvalued one moves prices until the riskless profit disappears. It does not widen mispricing or need central bank intervention.

  1. AArbitrage trades push quotes toward consistency with the implied cross rateCorrect
  2. BArbitrage widens the mispricing until central banks intervene
  3. CArbitrage leaves the quoted rates unchanged and affects only the bid-ask spread

Explanation

Traders buying the undervalued currency and selling the overvalued one move quotes until the cross rate equals the implied rate and the profit disappears. It does not widen mispricing.

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