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Opportunity for locational arbitrage

In the data of [10 currencies × five banks × five days] 250 bid and ask quotes collected from 26/04/2010 to 30/04/2010, there is not any group of bid and ask quotes makes it possible to make a locational arbitrage. The locational arbitrage is a process that purchases a kind of currency in a location where it is priced cheap, and then sells the currency immediately in other place for a higher price. Therefore, the bid and ask quotes decide the price of the currency. To buy a currency will use the ask quote as the exchange rate to count how much you can get. The bid quote is the exchange rate to count when a currency is sold. The ...view middle of the document...

The different quote between banks will encourage people to make a locational arbitrage. Because of the gap of quote change the amount of demand and supply. The locational arbitrage will make the different quote realign. That is why in the real currency it is hard or even impossible to find the opportunity to make a locational arbitrage.

4-26 highest bid lowest ask

USD 6.8135 6..8406

EUR 9.1037 9.1709

GBP 10.5315 10.6107

CAD 6.8127 6.8644

HKD 0.8777 0.881

JPY 0.0723 0.0728

AUD 6.3225 6.366

SGD 4.9735 5.0108

CHF 6.3414 6.3887

SEK 0.9505 0.9574

Opportunity for triangular arbitrage

Triangular arbitrage, as a method of international arbitrage, refers to gain risk-free advantages of imbalance between three foreign exchange markets. If the appropriate cross exchange rate is of difference from a quoted cross exchange rate, then the Triangular arbitrage can be used in which the currency transactions are conducted in the spot market to capitalize on a discrepancy in the cross exchange rate between two currencies.

As we can see from the tables above, in the day 26th April 2010, $1 USD can be bought by using ￥6.8263 CNY in BANK OF CHINA. In the same date, Chinese yuan (CNY) against Australian dollar (AUD) is ￥6.3332 CNY/$USD. As a consequence, the appropriate cross exchange rate between AUD and USD is $1.07785AUD/$USD. However, the quoted cross exchange rate of AUD against USD is $1.0782AUD/$USD which differs from the appropriate cross exchange rate determined through the data from BANK OF CHINA. Consequently, we can obtain benefits from the Triangular arbitrage.

Assume that we have ￥10000 CNY, the details of the Triangular arbitrage can be listed as follow. Firstly, we can buy $1465 USD by using the CNY on hand in BANK OF CHINA. Secondly, we can buy AUD in the HSBC by using USD then we can get $1579.63 AUD. However, if we buy AUD from BANK OF CHINA by using USD then we can get $1579.05 AUD. In this way, we can get $0.58 AUD. Thirdly, we can buy ￥10003.9899CNY in BANK OF CHINA by using AUD. As a result, we can gain ￥3.9899 CNY risk-free profit every ￥10000 CNY by using the Triangular arbitrage.

As the example above, the formula Sd/e*Se/f*Sf/d=1 can be used to estimate the possibility of Triangular arbitrage. If Sd/e*Se/f*Sf/d=1, then there will be no possibility to obtain benefits through Triangular arbitrage. If Sd/e*Se/f*Sf/d<1, then either Sd/e, Se/f or Sf/d must rise. And for each spot rate, buy the currency in the denominator with the currency in the numerator. If Sd/e*Se/f*Sf/d>1, then either Sd/e, Se/f or Sf/d must fall. And for each spot rate, sell the currency in the denominator with the currency in the numerator.

In this essay, we have tested five currencies (USD, GBP, CAD, AUD, and JPY) to see whether they have possibilities of Triangular arbitrage. The results of the tests can be listed as follow:

26-Apr

27-Apr

28-Apr

...

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