Module 11.1, LOS 11.b: Currency Cross Rates and Triangular Arbitrage

The cross rate is the exchange rate between two currencies implied by their exchange rates with a common third currency. It is necessary to use cross rates when there is no active foreign exchange (FX) market in the currency pair being considered. 

For triangle arbitrage, invert using opposite’s rates and cross multiply same type rates. We begin with three pairs of currencies, each with bid and ask quotes, and construct a triangle where each node in the triangle represents one currency. To check for arbitrage opportunities, we go around the triangle clockwise (and later, counterclockwise) until we reach our starting point.

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