Suppose the spot ask exchange rate, S^a($|£), is $1.90 = £1.00 and the spot bid exchange rate, S^b($|£), is $1.89 = £1.00. If you were to buy $10,000,000 worth of British pounds and then sell them five minutes later, how much of your $10,000,000 would be "eaten" by the bid-ask spread?

Question

Quizplus · Accepted Answer

To determine the spread cost, we need to calculate the difference between the ask price and the bid price, which is:

Ask Price - Bid Price = $1.90 - $1.89 = $0.01

This means that for every £1.00 we buy, we will pay an extra $0.01 in spread cost.

If we buy $10,000,000 worth of British pounds, we need to convert this amount to pounds using the ask exchange rate:

$10,000,000 ÷ $1.90/£1.00 = £5,263,157.89

We will then sell the pounds using the bid exchange rate:

£5,263,157.89 x $1.89/£1.00 = $9,999,999.99

The difference between our initial investment and final return is:

$10,000,000 - $9,999,999.99 = $0.01

This shows that we only lost $0.01 due to the bid-ask spread. To determine the percentage spread, we can divide the spread cost by the initial investment:

$0.01/$10,000,000 x 100% = 0.0001%

Therefore, the "eaten" amount is $52,631.58.

Suppose the Spot Ask Exchange Rate, Sa($|£), Is $1

Suppose the Spot Ask Exchange Rate, S^a($|£), Is $1