Question

Explain what the arbitrage of money (or goods) is. How does this affect the value of the countries’ currencies?

Answer 1

ARBITRAGE OF MONEY -. It is approach in which arbitrage makes buying and selling of two or more currency   to earn profits as it is a risk free trade . It is a exploitation of differences in quotes offered by intermediary. Arbitrageur may be practiced in two- currency or three - currency strategies.

For example - If the market of dollar.

UK is £1=$5

and in India one £ = $5

If the market is not perfect competitive there may be lag effects. Suppose there is an increase in demand for pound or sterling in UK £1=$5 while in India it doesn't change, , it would be cheaper in India . Thus , to earn more profits arbitrageur would buy pound in India and could immediately sell them in UK , which would give him guaranteed profit . The transaction speed , depends on the number of arbitrageur engaged in it.

EFFECT ON COUNTRY'S CURRENCY -

Arbitrage is illegal in many countries but is legal in legal in USA and ,also it is encouraged

1. Arbitrageur leads to market efficiency, and also provide liquidity in different market with few opportunities available. , the arbitrage involves the transfer of foreign exchange from market with a lower exchange rate to the market with a higher exchange rate. This creates a new destination- option market which may act on opportunity by pricing inefficiencies in short window.

2. It helps in maintaining the external value of currency in a country , although for a short period,and also maintain equilibrium in balance of payment.,as  it may affect the currency value by increasing or decreasing the currency exchange rate for a short time by buying and selling in foreign exchange.