Question

Assume that the real exchange rate is equal 4 US goods/CAN goods. Also, assume that P
US = 1 and P CAN = 2
as well as that there are no transportation costs and all goods are tradable. Suppose that there is a Canadian investor looking to invest C$1, 000 by buying goods in one market and selling them in the other. What is the maximum profit the investor can make if she takes advantage of the arbitrage opportunity (express profits in C$)?

Answer 1

4 US goods = 1 Canadian goods

buy from US sell to Canada

$1000\times4=4000$

buy

$\frac{4000}{1}=4000$ units in US

can sell these units in canada for

$4000\times2=8000$

Maximum profits = C$8000 - C$1000 = C$7000