Question

Use Economics of globalization view to Explain with examples（at least three）of arbitrage in exchange rate

Answer 1

Arbitrage in exchange rate:

Arbitrage occurs when an investor simultaneously buys and sells an asset in attempt to benefit from an existing price difference on similar or identical securities.The arbitrage technique enables investors to self-regulate the market and aid in smoothing out price differences to ensure that securities continue to trade at a fair market value.

For example

I) In context of the stock market,traders often try to exploit arbitrage opportunities like a buyer may buy a stock on a foreign exchange where the price has not yet adjusted for the constantly fluctuating exchange rate.The price of the stock on the foreign exchange is therefore undervalued compared to the price on the local exchange, and the trader makes a profit from this difference.

2) There are two banks(Bank A and Bank B) offer quote for USD/JPY currency pair. Bank A sets the rate at 3/2 dollars per yen, and Bank B sets it's rate at 4/3 dollars per yen.In currency arbitrage, the trader would take one yen,convert that into dollars with Bank A and then back into Yen with Bank B.The result is that the trader who started with One yen now has 9/8 yen.The trader has made a 1/8 yen profit if trading fees are nil.

3. If the exchange rate in London is €1 =$2 while the exchange rate in the U.S. is €1 =$3, then a smart consumer can make a profit by converting their money into dollars to pounds in London, then converting back when they return to the U.S.