If a bottle of fine French wine costs US$250 in the U.S., 2500 rand in South Africa, there are transaction costs of US$50, and the exchange rate is 20 rand/US$, then

Question

Quizplus · Accepted Answer

To determine if there is an arbitrage opportunity, we need to compare the cost of buying and selling the wine in both markets.

In the U.S.:
Cost of the wine: US$250 + US$50 transaction costs = US$300
Converted cost in rand: US$300 x 20 rand/US$ = 6,000 rand

In South Africa:
Cost of the wine: 2,500 rand
Converted cost in US$: 2,500 rand / 20 rand/US$ = US$125

If we were to buy in South Africa and sell in the U.S., we would make a profit of US$125 - US$300 = -US$175, which means we would make a loss.

However, if we were to buy in the U.S. and sell in South Africa, we would make a profit of 6,000 rand - 2,500 rand = 3,500 rand. Therefore, there is an arbitrage opportunity by buying the wine in South Africa and selling it in the U.S., and the price in the U.S. will drop.

If a Bottle of Fine French Wine Costs US$250 in the U.S