Only the fastest traders can take advantage of arbitrage opportunities and algorithmic trading now dominates this part of the market. You have decided to set up an arbitrage hedge fund and have hired...

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Only the fastest traders can take advantage of arbitrage opportunities and algorithmic trading now dominates this part of the market.  You have decided to set up an arbitrage hedge fund and have hired a computer expert to turn your insight into computer algorithms.  Your expert does not understand finance.  He has given you the following schematic diagram of how he usually constructs algorithms and has asked you to explain as simply as possible what he needs to do at each step. 1. Outline the basic idea of the arbitrage opportunity you are trying to identify as clearly as possible (try to use CIP arbitrage but if you are really struggling you can use triangular arbitrage instead). 2. Tell him the exact nature of the data he needs to include. 3. Specify the trading rule he needs to follow to take advantage of any arbitrage opportunities. 4. Detail how he should test the performance of the strategy using a historical database. 5. Explain any risks in the strategy that may compromise its performance and that he may need to account for in writing the algorithm.