Question

Give an example of Locational Arbitrage and a scenario necessary for it  
to be plausible. How could an MNE benefit from such a scenario?

Answer 1

Locational arbitrage: Situation where spot rates of a particular set of currencies differ at different location. In such a situation, a currency trader can make arbitrage profit without any risk and initial investment just by buying currency at one location and selling it at another.

An example of Locational Arbitrage:

Let's look at the bid and ask rate quoted for 1 Euro in terms of $ at two different banks say AZB and Goldman.

Exchange rate: ____$ / Euro	Bid	Ask
AZB Bank	1.135	1.138
Goldman Bank	1.131	1.133

We begin with $ 1,000,000 in hand. We can buy Euro from Goldman Bank. We will have to pay the Ask price. So, we end up with = Euro 1,000,000 / 1.133 =  Euro 882,613

We then proceed to sell these Euro to AZB Bank at another location. We will get the bid price. So, number of $ we will get back in exchange = $ 882,613 x 1.135 = $  1,001,765

Thus, we make an arbitrage profit of  1,001,765 - 1,000,000 = $ 1,765 merely because of different spot rate for $ - Euro combination prevailing at two different locations. This is a locational arbitrage.

Scenario necessary for it to be possible:

Please note that we could make the arbitrage possible in above case because:

1. There are different spot rates prevailing at two different locations and
2. Bid rate at one location (AZB Bank) > Ask rate at another location (Goldman Bank)
3. Transaction costs are nil or minimal

The most important criteria is the second point.

How could an MNE benefit?

An MNE can benefit from this by buying the currency at one location and immediately selling it at another location. An MNE has to identify such arbitrage opportunities and execute them to take advantage. The MNE has to buy the currency at a location where ask price is lower than the bid price at some other location, and then sell it at the other location.