Consider the following spot exchange rates: $2.56/£, ¥65.62/$, DM1.0/$, and L1,263/$.Which of the following seems to violate the law of one price if gold sells for $464 per ounce in the Canada? Dollars in the exchange rates are Canadian.

Question

Quizplus · Accepted Answer

To see whether the law of one price is violated, we need to calculate the price of 1 troy oz. of gold in Canadian dollars using each exchange rate.

Using the first exchange rate, we get:

1 troy oz. gold = £181,250 
1 £ = $2.56 CAD 
1 troy oz. gold = $465,600 CAD

Using the second exchange rate, we get:

1 troy oz. gold = ¥30,448
1 ¥ = $0.015 CAD 
1 troy oz. gold = $456.72 CAD

Using the third exchange rate, we get:

1 troy oz. gold = DM464 
1 DM = $0.71 CAD 
1 troy oz. gold = $329.44 CAD

Using the fourth exchange rate, we get:

1 troy oz. gold = L550,500
1 L = $1.58 CAD
1 troy oz. gold = $869,490 CAD

So we see that using exchange rate D, the price of 1 troy oz. of gold in Canadian dollars is significantly higher than the price calculated using the other exchange rates. This violates the law of one price, because it suggests that there is an opportunity for arbitrage (buying gold in one market and selling it in another market to make a profit). Therefore, the correct answer is D.

Consider the Following Spot Exchange Rates: $2