What Is International Arbitrage?

International Arbitrage refers to the use of different foreign exchange markets, different currency types, different delivery times, and differences in exchange rates and interest rates of some currencies to buy from the low-priced side and sell from the high-priced side, thereby earning money from it Profitable foreign exchange trading activities.

International arbitrage

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International Arbitrage refers to the use of different foreign exchange markets, different

International arbitrage is generally divided into: location arbitrage,

Location Arbitrage refers to an international arbitrage behavior in which investors make use of the differences between the exchange rates of certain currencies in two different foreign exchange markets to buy and sell expensively in the markets of the two places at the same time, thereby earning differential profits. .

Example: On the London market,

Cross Arbitrage refers to three or more

Covered Interest Rate Arbitrage refers to the use of the interest rate difference between the two countries' markets to borrow currencies from countries with low interest rates, and to purchase currencies from countries with high interest rates, and to convert currencies from countries with high interest rates to Currency of countries with low interest rates, thus earning international arbitrage behavior of spread income; At the same time, investors purchase forward foreign exchange contracts, lock the exchange rate of the currency exchange, reduce the risk of second currency exchange, and avoid investing in high interest rate currencies for a period of time The subsequent depreciation reduces the spread income.

Take Britain and the United States as an example. If the interest rate in the United States is lower than the interest rate in the United Kingdom, the Americans are willing to convert the US dollar into British pounds at the spot exchange rate and deposit it in British banks. As a result, American demand for the pound has increased. The demand for the British pound has increased, and the spot exchange rate of the British pound has to increase, with other factors unchanged. On the other hand, in order to avoid the risk of exchange rate changes, arbitrageurs also signed contracts to sell forward pounds at the forward exchange rate, which increased the supply of forward pounds. The supply of forward pounds will increase, and the exchange rate of forward pounds will fall if other factors remain unchanged. Westerners have drawn such a conclusion based on experience in the foreign exchange market: the spot exchange rates of countries with higher interest rates are on the rise, and the forward exchange rates are on the decline. According to this law, the direction of capital flows is determined not only by the interest rate spread between the two countries, but also by the forward premium rate or discount rate of countries with high interest rates and the forward currency premium rate. The offset spread is CD, and the discount rate or premium rate of pound sterling is F .

CD = IukIus Ten F

If the UK interest rate Iuk = 10%, the US interest rate Ius = 4%, the forward pound discount rate F = 3%, CD = 10% 4% 3% = 3%) 0, then Will flow from the United States to the United Kingdom. Because arbitrageurs believe that although forward pound discounts reduce their profits, they still have a profit to make. If the discount rate for forward pounds F = 8%, other conditions remain unchanged, CD = 10% 4% 8% = 2% (0, at this time, capital will flow from Britain to the United States. Because the arbitrageur It is believed that the discount rate of forward pounds is too high, which not only reduces their profits, but also makes them negative. But the British are willing to convert pounds into dollars at the spot exchange rate and convert dollars into pounds at the forward rate So that capital flows from Britain to the United States.

Below, another example is used to illustrate the actual situation of offset arbitrage. The arbitrageur's principal is $ 1000, Iuk = 10%, Ius = 4%, the spot exchange rate for the pound is $ 2.8 / , and the forward rate for the pound is $ 2.73 / . Arbitrageurs exchanged US dollars for British pounds at the beginning of the year and deposited with British banks:

$ 1000 ÷ $ 2.8 / = 357

Interest earned after 1 year is:

357 × 10% = 35.7

According to the forward exchange rate of the contract signed at that time, it is equivalent to $ 97 ($ 35.7 × $ 2.73 / ). This is the gross profit of the arbitrageur. The opportunity cost of the arbitrage is subtracted from the 40 US dollars ($ 1000 × 4%). The profit is $ 57 ($ 97- $ 40). This example shows that while arbitrageurs buy spot sterling, they sell sterling at a higher forward sterling exchange rate to avoid losses caused by a significant decline in the sterling exchange rate. After 1 year, the spot sterling exchange rate is $ 2.4 / . Sterling is still sold at $ 2.73 / .