Arbitrage in Foreign Exchange Markets

Q.  What do you understand by Arbitrage in Foreign Exchange Markets ?

Arbitrage is the simultaneous taking of position in two or more markets in order to exploit a discrepancy between the prices of assets in the different markets.

It is different from the speculation. The speculator seeks profit from a change in price level while arbitrageur seeks profits from discrepancy in price levels in two markets.

Foreign exchange market, the term arbitrage refers to the purchase of a currency at the centre where it is cheaper and selling it at another centre where it is costlier to make a profit.

Foreign exchange market is efficient, the foreign exchange quotes in two different centers must be in line. However in case the rates are not same then there exist a difference in prices of the same currency at two different centre and it gives rise to arbitrage opportunity to make profit.

A dealer can make profit by buying at the centre where the currency is cheaper and selling it at another centre where the currency is dearer.

Such as buy and sell opportunity will involve no investment of funds and no risk bearing by the dealer but will provide a profit opportunity, called the arbitrage profit.

Process of arbitrage may be described as consisting of simultaneous selling and buying of the same currency in two different centers to make a risk-less profit. This type may be called a simple arbitrage or geographical arbitrage.

Another type is known as triangular arbitrage, when three currencies and three centers are involved.