Question

please give me an example with the rectangular arbitrage based on the real world data

thank you

Answer 1

Interest Rate Parity (IRP) - The linkage provided by the theory of Interest Rate Parity (IRP) is between the foreign exchange markets and the international money markets.

Covered interest arbitrage (CIA) – As described by interest rate parity, the spot and forward exchange rates are not, however, constantly in the state of equilibrium. The potential for “risk-less” or arbitrage profit exists, when the market is not in equilibrium. The arbitrager will exploit the imbalances, by investing in currency whichever offers the higher return on a covered basis.

Uncovered interest arbitrage (UIA) - A deviation from CIA is uncovered interest arbitrage (UIA). In this case, investors borrow in countries and currencies exhibiting relatively low interest rates and convert the proceed into currencies that offer much higher interest rates. The transaction is “uncovered” because the investor does no sell the higher yielding currency proceeds forward, choosing to remain uncovered. At the end of the period, the investor also accepts the currency risk of exchanging the higher yield currency into the lower yielding currency.

The investor borrows Japanese yen at relatively low interest rates in the yen carry trade, then converts the proceeds to another currency (such as U.S. dollar), where the funds are invested at a higher interest rate for a term. The investor exchanges the dollars back to yen to repay the loan, pocketing the difference as arbitrage profit at the end of the period. The investor profits if the spot rate at the end of the period is roughly the same as at the start, or the yen has fallen in value against the dollar. However, the investment may result in significant loss if the yen were to appreciate versus the dollar over the period.