The U.S. dollar spot exchange rate with the Australian dollar is $1 = AU$1.2219. The U.S. dollar and euro exchange rate is $1 = €0.7595. If the cross-rate between the euro and Australian dollar is €1 = AU$1.575 then show that an arbitrage is possible. What positions should be taken to profit from the mispricing?
A) Starting with U.S. dollars, buy Australian dollars and convert them to euros, then convert back to U.S. dollars.
B) Starting with U.S. dollars, buy euros and convert them to Australian dollars, then convert back to U.S. dollars.
C) Starting with euros, buy U.S. dollars and convert them to Australian dollars, then convert back to euros.
D) Starting with Australian dollars, buy euros and convert them to U.S. dollars, then convert back to Australian dollars.
Correct Answer:
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