Assume the following exchange rates: $1 = NZ$3, NZ$1 = MXP2, and $1 = MXP5. Given this information, as you and others perform triangular arbitrage, the exchange rate of the New Zealand dollar (NZ) with respect to the U.S. dollar should ____, and the exchange rate of the Mexican peso (MXP) with respect to the U.S. dollar should ____.
A) appreciate; depreciate
B) depreciate; appreciate
C) depreciate; depreciate
D) appreciate; appreciate
E) remain stable; appreciate

Question

Assume the following exchange rates: $1 = NZ$3, NZ$1 = MXP2, and $1 = MXP5. Given this information, as you and others perform triangular arbitrage, the exchange rate of the New Zealand dollar (NZ) with respect to the U.S. dollar should ____, and the exchange rate of the Mexican peso (MXP) with respect to the U.S. dollar should ____.​
A) ​appreciate; depreciate
B) ​depreciate; appreciate
C) ​depreciate; depreciate
D) ​appreciate; appreciate
E) ​remain stable; appreciate

Quizplus · Accepted Answer

Triangular arbitrage will correct the mispricing among currencies. Initially, $1 buys NZ$3, but through NZ$1 = MXP2 and $1 = MXP5, $1 should buy NZ$2.5 (since NZ$1 = MXP2 and MXP5 = $1, so NZ$1 = $0.4, or $1 = NZ$2.5). This means the NZ dollar will appreciate (as it takes fewer NZ dollars to equal $1), and the Mexican peso will depreciate (as it will take more pesos to equal $1, correcting the initial discrepancy).

Assume the Following Exchange Rates: $1 = NZ$3, NZ$1 =