While I am not a newbie I have a very newbie question that makes me a little confused when buying/selling a pair and wanted some one to help clarify my wrong thinking.
Question, and I have always had the idea with the stocks philosophy (buy low sell high) is if you were to for example buy GBP/USD at the ask price 2.00. This means you are buying GBP and selling USD at 2.00. Now say you had 20,000 GBP, how do you determine how much GBP you just bought when the rate was at 2.00? I know when you want to buy back the the USD and sell your GBP you want the rate to be higher because you get back more USD but how does that convert to more GBP if that is your investment currency? Thanks and hope that makes some reasonable sense?
When you are trading in GBP/USD you are buying/selling GBP. The size of your trade is in GBP. A lot of people make the erroneous assumtion that lot sizes are in USD when in fact they are in the base currency. That’s the first one in the pair. If you trade a full lot of GBP/USD you are trading 100,000 GBP, not 100,000 USD. To figure out how many of the quote currency (the second one in the pair) the lot represents you simply multiply the trade size by the rate.
Hi. Thanks. But I still do not see how it converts to profit in GBP currency.
Im actually working on a problem from class which we are discussing locational arbitrage.
The question asks
Bank A’s quotes are 1 euro = $1.55CDN (bid) and $1.5528CDN (ask).
Bank B’s quotes are 1 euro = $1.5780CDN (bid) and 1.5828CDN (ask).
You have Euro 25,000,000
(CDN=Canadian dollar)
What profits if any can you make in $CDN, if you do locational arbitrage?
What profits if any can you make in Euro, if you do locational arbitrage?
So what I initally thought to this question was to buy at the lower ask price and sell at the higher bid price. Well the answer states that you would sell Euro’s at Bank B (bid) and but them back at Bank A (ask).
So if I am selling at bank B euros and I am buying CDN then buying back euros at bank A and selling back CDN. Since CDN gained in value. Came out to be 630,000 profit in CDN. Well then it asks what profits in euro would you get and it came out to be 405, 718.00.
So they both came out in profit. I really dont get that because I always thought you were losing on one currency when gaining on the other?
I know this sounds like Im trying to get a hw question answered but Im not. Im just trying to understand the way the profits of each currency is figured out and my prof. doesnt do a very good job at explaining it. Thanks.
If you go to Bank B and use your 25,000,000 EUR to buy CAD you would end up with 39,450,000 CAD (25,000,000 x 1.5780). You then take that pile of CAD to Bank A and convert it back to EUR at 1.5528 receiving 25,405,718.70 EUR. Your profit is then 405,718.70 EUR.
