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      Question

      An Indian importer observes the following quotes in the

      interbank market: Direct Quote in India:Β 1 USD = β‚Ή83.50 Indirect Quote in India:Β 100 INR = 1.22 USDΒ  Β  Β  Β  Β  Β  Β Based on these quotes, which of the following statements is mathematically accurate regarding the relationship between these two rates?
      A The quotes are perfectly aligned, and no arbitrage opportunity exists. Correct Answer Incorrect Answer
      B The Indirect Quote implies a USD rate of β‚Ή81.97, suggesting the USD is undervalued in the indirect market. Correct Answer Incorrect Answer
      C The Indirect Quote implies a USD rate of β‚Ή83.50, maintaining the Law of One Price. Correct Answer Incorrect Answer
      D The Direct Quote suggests that 100 INR should be worth 1.19 USD. Correct Answer Incorrect Answer
      E The Indirect Quote is exactly the reciprocal of the Direct Quote. Correct Answer Incorrect Answer

      Solution

      A Direct Quote is 1 πΉπ‘œπ‘Ÿπ‘’π‘–π‘”π‘› π‘ˆπ‘›π‘–π‘‘ = 𝑋 π»π‘œπ‘šπ‘’ π‘ˆπ‘›π‘–π‘‘π‘  i.e. 1 USD = β‚Ή83.50. An Indirect Quote is 1 π»π‘œπ‘šπ‘’ π‘ˆπ‘›π‘–π‘‘ = 𝑋 πΉπ‘œπ‘Ÿπ‘’π‘–π‘”π‘› π‘ˆπ‘›π‘–π‘‘π‘  i.e. β‚Ή100 = 1.22 USD Β  or β‚Ή1 = 0.0122 USD Β  To compare, find the Implied Direct Rate from the indirect quote: Β  = 1/indirect quote = 1/0.0122 = 81.967 Β  As β‚Ή81.97 (as calculated) is lower than β‚Ή83.50 (Directly quoted), the USD is cheaper via the indirect route, creating a potential arbitrage opportunity.

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