This topic continues to make me feel like a moron. I just do no conceptually get the arbitrage calculation movements when bid/ask spreads are introduced. Here are the fundamentals that I can grasp. US/CAD = CAD:US This is a direct quote from the perspective of US currency. US is the counter currency and CAD is the base currency As the numerator declines, the currency is APPRECIATING If given US/CAD Bid-Ask Spread of 1.23-1.25, this is the equivalent to CAD/US 0.80-0.813 Now, where I start to get screwed up. If I have US1,000,000 and I want to convert it to Canadian dollars, what is the process given those above rates. Am I buying CAD or selling US, and isn’t that really just the same thing?
You’re buying CAD.
“Up the Bid, Down the Ask” In other words, if you are going from USD to CAD, you are going DOWN the ratio in this case (draw a line from the numerator to denominator). So “down the ask” means you look to the ask in the quote. From there, you know you have $1,000,000 and need to use the 1.25 number - the question is whether you multiply or divide. I look at it like this: you have (1,000,000USD/1) and are looking to use 1.25 (USD/CAD) - so (USD/1) and (USD/CAD). If you multiply, you’ll have (USD^squared/CAD), which doesn’t make sense. If you divide, the USDs cancel and you are left with CAD. You could also invert the USD/CAD quote (1/1.25=0.8) and multiply, which should give you the same thing. That’s how I solve these.
My trick is the following…it’s reeeeally easy… EXAMPLE: they give you bid-ask spreads for the following: USD/CAD USD/GBP they ask you to find GBP/CAD First… put the bid ask spreads in the form you need them… i.e. grab the second term (USD/GBP) and put it so that it is… GBP/USD… the only thing to remember is that by taking the reciprocals…the bid becomes the ask… and the ask becomes the bid for that second term… Finally… multiply you two bids …multiply your two asks… and you are done…