arbitrage

Arbitrage overview

Arbitrage refers to the use of differentforeign exchange marketThe foreign exchange spread, buying a certain currency in one foreign exchange market and selling it in another foreign exchange market to make a profit. In arbitrage, there are two-corner arbitrage, triangular arbitrage and multi-corner arbitrage due to the different foreign exchange markets involved.

Arbitrage

Two-corner arbitrage is the use of the exchange rate difference between the two places to buy a currency at a low price in one foreign exchange market and sell the currency at a high price in the other foreign exchange market to make a profit. Because it is between the two markets, the arbitrageur directly participates in the transaction, so it is also called direct arbitrage.

For example, in the London foreign exchange market, the spot exchange rate of the pound against the dollar is:

1 pound sterling = $1.98 or $1 = 0.505 pounds sterling

In the New York foreign exchange market, the spot exchange rate between the pound and the dollar is:

1 pound sterling = $2.00 or $1 = 0.5 pounds sterling

Obviously, in the London foreign exchange market, the price of the pound is low because the pound is the national currency and is in abundant supply. In the New York foreign exchange market, the pound is foreign exchange, and the supply is insufficient, and the price of the pound is high. Similarly, the dollar is low in the New York foreign exchange market and high in the London foreign exchange market.

If an arbitrageur buys 1,000 pounds for 1980 dollars in London, and sells 1,000 pounds in New York for 2,000 dollars at the same time. This simple buy and sell makes the arbitrageur earn $20. Some arbitrageurs spend dollars in London to buy pounds at a low price, and the demand for pounds increases, driving the price of pounds up. Arbitrageurs sell pounds in New York, and the supply of pounds increases, causing the price of pounds to fall. It can be seen that the speculative behavior of arbitrageurs will spontaneously level the prices of the two foreign exchange markets in London and New York, spontaneously harmonize the supply and demand of the two foreign exchange markets, and make the two foreign exchange markets operate more efficiently. According to this, Westerners believe that arbitrage is indispensable for regulating the supply and demand of foreign exchange, and arbitrage activities are justified. When buying and selling foreign exchange, there is a handling fee. The net profit of the arbitrageur is equal to the gross profit minus the handling fee spent when buying and selling foreign exchange.

Triangle arbitrage

Triangular arbitrage refers to the use of three foreign exchange markets on the difference in foreign exchange, in the three foreign exchange markets at the same time to buy cheap and sell, in order to earn profits. Triangular arbitrage is also called indirect arbitrage.

Suppose: 1 pound sterling = $2 in the London foreign exchange market

1 pound sterling on the Paris foreign exchange market = Fr10

$1 = Fr5 on the New York foreign exchange market

In this case, if you don't take into account the handling fee for buying and selling foreign exchange, a certain arbitrageur buys $200 for £100 in London, 1,000 French francs for $200 in the New York foreign exchange market, and another 100 pounds for 1,000 francs in the Paris foreign exchange market. At the end of the transaction, the arbitrageur takes out £100 to get back £100, without adding a penny, and also spends telegraph and handling fees in vain.

This example shows that the triangular arbitrage value is not worth doing, unlike the two-corner arbitrage. First, it depends on whether the cross exchange rate between the three currencies involved above is consistent with the open exchange rate. The cross exchange rate is also called the hedging rate, and the exchange rate between the two currencies is indirectly calculated by the exchange rate between the two currencies and the third country's currency. According to the above situation, in the London foreign exchange market, 1 pound sterling = $2, and in the Paris foreign exchange market, 1 pound sterling = Fr10, resulting in $2 = Fr10, $1 = Fr5.

This $1 = Fr5 is calculated using the open exchange rate of the pound to the dollar and the open exchange rate of the pound to the franc. This set exchange rate is exactly the same as the open exchange rate of $1 = Fr5. Similarly, according to the exchange rate of the dollar to the franc, the exchange rate of the dollar to the pound can also be calculated to be exactly the same as the open exchange rate. From this, it can be concluded that if the set exchange rate is exactly the same as the open exchange rate, there is no condition for triangular arbitrage, and triangular arbitrage cannot be carried out. Triangular arbitrage can only be carried out if the set exchange rate is inconsistent with the open exchange rate, and it can be profitable. For example:

In the London foreign exchange market 1 pound sterling = $2

On the Paris foreign exchange market 1 pound sterling = Fr10

In the New York foreign exchange market, $1 = Fr6.

According to the exchange rate between the pound and the dollar and the pound and the franc in the London and Paris foreign exchange markets, the hedged exchange rate between the dollar and the franc is $1 = Fr5, while the public exchange rate between the dollar and the franc is $1 = Fr6. It can be seen that the hedged exchange rate is inconsistent with the public exchange rate, providing conditions for engaging in triangular arbitrage. The arbitrageur buys $200 for £100 in London, while buying 1,200 francs for $200 in the New York foreign exchange market, and £120 for 1200 francs in the Paris foreign exchange market. The arbitrageur takes out £100, gets back £120, and the triangular arbitrage profit is £20.

The triangular arbitrage plays the same role in the foreign exchange market as the two-corner arbitrage. When the open exchange rate of the dollar and the franc is inconsistent with the cross exchange rate, and the open exchange rate is higher than the cross exchange rate, the arbitrageur will increase the supply of dollars and sell dollars at a high price to buy francs. The supply of dollars increases, the price of the dollar gradually decreases, the price of the franc gradually rises, and finally the price of the dollar falls to 1 dollar = 5 francs, so that the cross exchange rate is consistent with the open exchange rate, eliminating the condition of triangular arbitrage. Therefore, triangular arbitrage can also adjust the supply and demand relationship of three different foreign exchange markets, making the foreign exchange market operate more efficiently.

Overview of arbitrage trading

Arbitrage transactions refer to foreign exchange transactions that take advantage of differences in exchange rates or interest rates at different times (delivery periods) and different places (foreign exchange markets) to prevent exchange rate risks and obtain arbitrage profits.

The arbitrage market is the largest financial trading market in the world, with an average daily trading volume of 1.50 trillion. Arbitrage refers to the act of buying one currency of a pair of currencies and selling another currency at the same time. The exchange rates of various currencies in the international market fluctuate frequently with each other and are traded in the form of currency pairs, such as EUR/USD or USD/JPY.

Due to the different types of differences, arbitrage can be divided into place arbitrage and time arbitrage.

The conditions for arbitrage

In general, to arbitrage, the following three conditions must be met:

(1) There are different foreign exchange markets and exchange rate differentials.

(2) The arbitrageur must have a certain amount of capital and a branch or correspondent bank in the main foreign exchange market.

(3) The arbitrageur must have certain skills and experience to be able to judge the exchange rate changes and trends in various foreign exchange markets, and to predict

Take action quickly. Otherwise, more complex arbitrage will be twice the result with half the effort.

Location of arbitrage transactions

Arbitrage trading is not centralized on a single exchange like stocks and futures. In fact, two parties to a transaction can complete a transaction through a single phone call or an electronic trading network. Therefore, the arbitrage market is called an over-the-counter (OTC) or "interbank" trading market.

Participants in the arbitrage market

The arbitrage market is called an "interbank" market because it has long been controlled by banks, including central banks, commercial banks, and investment banks. Today, however, the body of trading is rapidly expanding, including multinational companies, international currency managers, registered dealers, international currency brokers, futures and options traders, and private speculators.

Time of arbitrage

In fact, the arbitrage market is an instant 24-hour trading market, trading starts every day in Sydney, and as the earth turns, the business day will start in each financial center around the world, first in Tokyo, then in London, and New York. Unlike other financial marekts, in the arbitrage market, investors can react to exchange rate fluctuations caused by economic, social and political events that occur during the day or night.

Currency types of arbitrage transactions

In arbitrage transactions, the main trading currencies are those issued by politically stable countries, recognized by the central bank, with relatively stable exchange rates, usually used for trading or highly liquid currencies. Today, about 85% of daily trading volume is in these major currencies, including the US dollar, Japanese yen, euro, British pound, Swiss franc, Canadian dollar and Australian dollar.