Foreign Exchange

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

This preview shows pages 1–2. Sign up to view the full content.

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

This preview has intentionally blurred sections. Sign up to view the full version.

View Full Document
This is the end of the preview. Sign up to access the rest of the document.

## This note was uploaded on 03/06/2011 for the course OSCM 230 taught by Professor Dong during the Spring '08 term at Washington University in St. Louis.

### Page1 / 2

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

This preview shows document pages 1 - 2. Sign up to view the full document.

View Full Document
Ask a homework question - tutors are online