Foreign Exchange - Foreign Exchange Arbitrage On a specific...

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1 Foreign Exchange Arbitrage On a specific day in Oct. 2007 the exchange rate between US$ to UK was 0.4881, and the reverse rate (from UK to US$) was 2.0486. If a company wanted to exchange $1,000 to UK they would receive 488.10 (=$1000*0.4881). 1 If they then took the resulting funds and converted them back to US$ they would receive $999.92166 (= 488.10*2.0489). The difference is the bid – ask spread . This is the premium paid for making a “round trip” transaction. The bid price for UK is 1 =$2.0486. How much the bank is willing to pay (in US$) for 1 The ask price or offer price for UK is 2.04876=1/0.4881. This is how much the bank charges for 1 A quote is the bid and ask price, which is: $ / : [2.0486, 2.04876] Arbitrage : Occasionally, there arise arbitrage opportunities when the relative exchange rates are not aligned. If, for example, the rate from UK to US$ was 2.06 then an investor could create a “money pump” by trading US$ to UK , back to US$ and so forth. In this case: $1,000  488.10  $1005.486
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Foreign Exchange - Foreign Exchange Arbitrage On a specific...

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