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ARBITRAGE

What is Arbitrage?
The simultaneous buying and selling of securities, currency, or
commodities in different markets or in derivative forms in order to
take advantage of differing prices for the same asset.
Profiting from differences inpricesoryieldsin differentmarkets.

Arbitrage in Spot Market


A spot market is the market where immediate sale and purchase
of forex takes place. The transactions are conducted for the spot
delivery of currency.
The key participants in spot market are banks of different country
origins.
The currencies are traded in form of bank deposits and transferred
from sellers account to buyers account, with instructions in form
of electronic messages.

Forms of Arbitrage in Spot Market


Inter-Bank Arbitrage
Two-Point Arbitrage
Triangular Arbitrage
Cross Exchange Rates

Inter-Bank Arbitrage
Aformof simultaneouscasharrangementby abankfrom
differentmarkets.
Itborrowscash from theinterbank marketand thesamecash is
then deposited locally at a higher interest rate.
Thegoalis to ultimatelymakea risklessprofiton the extra cash
earned from theinterest rates.

Two-Point Arbitrage
Buying a currency at one market & selling it at higher price in
another market is known as Two-Point Arbitrage'.
Consider the following spot quotations: Zurich Bank quotes:
USD/CHF 1.4955/1.4962 & a Bank in New York quotes: CHF/USD
0.6695/0.6699
To acquire one million Swiss francs from Zurich Bank $(1,000,000 +
1.4955)=$6,68,700 has to be invested.
At New York Bank, $ (0.6695 X 1,000,000) = $6,69,500 has to be
spent to acquire one million Swiss francs

There is arbitrage if we buy one million Swiss francs against $ from


the Zurich bank & sell them to New York bank i.e. $800.
To prevent arbitrage, New York bank's (CHF/USD) quotes must
overlap the (CHF/USD) quotes implied by the Zurich Bank (worked
out to be 0.6686/0.6690).
Foreign exchange markets very quickly eliminate two-point
arbitrage.

Triangular Arbitrage
Triangular arbitrage(also referred to asthree-point arbitrage) is the
act of exploiting anarbitrageopportunity resulting from a pricing
discrepancy among three differentcurrenciesin theforeign exchange
market.
A triangular arbitrage strategy involves three trades, exchanging the
initial currency for a second, the second currency for a third, and the
third currency for the initial.
A profitable trade is only possible if there exist market imperfections.
Profitable triangular arbitrage is very rarely possible because when
such opportunities arise, traders execute trades that take advantage
of the imperfections and prices adjust up or down until the
opportunity disappears

Cross Exchange Rates


A cross exchange rate is an exchange rate between a currency pair
where neither currency is the US dollar.
Under this method, exchange rate of third currency is calculated
in respect of either one of the pair currencies those rate are
known.
In foreign exchange market, there are some selected currencies
those dominated on other currencies for e.g. dollar, euro, franc
and yen etc.
This method is also called as Chain rule.

Arbitrage in Forward Market


Buying and selling forward, i.e., into the future.
Transfer purchasing power across currencies and across time
Market expectations
As long as there is profitable arbitrage opportunity the market can
not be in equilibrium.
Market can be said to be equilibrium when no profitable arbitrage
opportunity exist.

Types of Arbitrage
Location Arbitrage
Arbitrage without the Cost of Transaction
Telecom Arbitrage

Telecom Arbitrage
Telecom arbitrage companies allow phone users to make international calls for
free through certain access numbers. Such services are offered in the United
Kingdom; the telecommunication arbitrage companies get paid an
interconnect charge by the UK mobile networks and then buy international
routes at a lower cost. The calls are seen as free by the UK contract mobile
phone customers since they are using up their allocated monthly minutes
rather than paying for additional calls.
Such services were previously offered in the United States by companies such
as FuturePhone.com.These services would operate in rural telephone
exchanges, primarily in small towns in the state of Iowa. In these areas, the
local telephone carriers are allowed to charge a high "termination fee" to the
caller's carrier in order to fund the cost of providing service to the small and
sparsely populated areas that they serve. However, FuturePhone (as well as
other similar services) ceased operations upon legal challenges from AT&T and
other service providers