Finc 327 Ch 7 arbitrage

Question 1

Arbitrage

Answer 1

capitalizing on a discrepancy in quoted prices by

making a riskless profit.

Question 2

Locational Arbitrage

Answer 2

process of buying a currency at a location where it is priced
cheap and then immediately selling it at some other location where it is priced higher

Question 3

Banks’s ask price

Answer 3

price that the bank is selling currency for and what you are buying for

Question 4

bank’s bid price

Answer 4

price that the bank is buying currency for and what you are selling for

Question 5

Gains from Locational Arbitrage

Answer 5

Your gain from locational arbitrage is based
on two factors: the amount of money that you use to capitalize on the exchange rate
discrepancy; and the size of that discrepancy.

Question 6

Realignment Due to Locational Arbitrage

Answer 6

the high demand for New Zealand dollars at North Bank (resulting from arbitrage activity) will cause a shortage of New Zealand dollars there. As a result of this shortage,
North Bank will raise its ask price for New Zealand dollars. The excess supply of New Zealand
dollars at South Bank (resulting from sales of New Zealand dollars to South Bank in exchange for
U.S. dollars) will force South Bank to lower its bid price. As the currency prices are adjusted, gains
from locational arbitrage will be reduced.

Question 7

Triangular Arbitrage

Answer 7

If a quoted cross exchange rate differs from
the appropriate cross exchange rate (as determined by the preceding formula), you can
attempt to capitalize on the discrepancy.

Question 8

triangular arbitrage math

Answer 8

USD to pounds (ask rate) selling USD
pounds to ringgit (bid rate) buying ringgit
ringgit to USD (bid rate) buying USD

Question 9

Realignment Due to Triangular Arbitrage

Answer 9

1. Participants use dollars to purchase
   pounds.
   Bank increases its ask price of pounds with respect to the
   dollar.
2. Participants use pounds to purchase
   Malaysian ringgit.
   Bank reduces its bid price of the British pound with respect
   to the ringgit; that is, it reduces the number of ringgit to be
   exchanged per pound received.
3. Participants use Malaysian ringgit to
   purchase U.S. dollars.
   Bank reduces its bid price of ringgit with respect to the
   dollar.

Question 10

Covered interest arbitrage

Answer 10

the process of capitalizing on the difference in interest rates between two countries while covering your exchange rate risk with a forward contract.

Question 11

Realignment Due to Covered interest arbitrage

Answer 11

As many investors capitalize on covered interest arbitrage, there is downward pressure on the 90-day forward rate. Once the forward rate has a discount
from the spot rate that is about equal to the interest rate advantage, covered interest arbitrage
will no longer be feasible.

Question 12

Covered interest arbitrage using bid ask spread

Answer 12

1. convert using ask quote
2. amt grows in bank using interest rate
3. sell amt at forward rate aka bid quote

Question 13

interest rate parity (IRP).

Answer 13

When market forces cause interest rates and exchange rates to adjust such that covered
interest arbitrage is no longer feasible

Question 14

If IRP exists, then the rate of return R achieved from covered interest arbitrage should
be equal to

Answer 14

rate ih available in the home country