Ch07 PP 06

Ch07 PP 06 - Chapter 7 International Arbitrage And Interest...

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7 - 1 Chapter 7 International Arbitrage And Interest Rate Parity International Arbitrage Arbitrage can be loosely defined as capitalizing on a discrepancy in quoted prices to make a riskless profit. The effect of arbitrage on demand and supply is to cause prices to realign, such that no further risk-free profits can be made.
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7 - 2 As applied to foreign exchange and international money markets, arbitrage takes three common forms: ¤ locational arbitrage ¤ triangular arbitrage ¤ covered interest arbitrage International Arbitrage
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7 - 3 Locational arbitrage is possible when a bank’s buying price (bid price) is higher than another bank’s selling price (ask price) for the same currency. Example Bank C Bid Ask Bank D Bid Ask NZ$ $.635 $.640 NZ$ $.645 $.650 Buy NZ$ from Bank C @ $.640, and sell it to Bank D @ $.645. Profit = $.005/NZ$. Locational Arbitrage
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7 - 4 Triangular arbitrage is possible when a cross exchange rate quote differs from the rate calculated from spot rate quotes. Example Bid Ask British pound (£) $1.60 $1.61 Malaysian ringgit (MYR) $.200 $.202 British pound (£) MYR8.10 MYR8.20 MYR8.10/£ × $.200/MYR = $1.62/£ Buy £ @ $1.61, convert @ MYR8.10/£, then sell MYR @ $.200. Profit = $.01/£. Triangular Arbitrage
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7 - 5 Value of MYR in $ MYR Value of £ in MYR When the actual and calculated cross exchange rates differ, triangular arbitrage will force them back into equilibrium. Triangular Arbitrage £ Value of £ in $ US$
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Covered interest arbitrage is the process of capitalizing on the interest rate differential between two countries while covering for exchange rate risk. Covered interest arbitrage
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Ch07 PP 06 - Chapter 7 International Arbitrage And Interest...

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