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Chapter 7 - Arbitrage in FX Markets

Susmel FINA 4360 International Financial Management Dept. of Finance Univ. of Houston Chapter 7 - Arbitrage in FX Markets Last Lecture We went over effect of government on St FX rate regimes: Fixed, free float & mixed. CB sterilized (no effect on domestic Money Markets ) and non-sterilized interventions. This Lecture Effect of Arbitrage on St Arbitrage Definition: It involves no risk and no capital of your own. It is an activity that takes advantages of pricing mistakes in financial instruments in one or more Markets . That is, Arbitrage involves (1) Pricing mistake (2) No own capital (3) No Risk Note: The definition we used presents the ideal view of (riskless) Arbitrage .

⋄ Steps (2) and (4) simultaneously done produce a FX swap transaction! In this case, we buy the FC forward at Ft,T and go sell the FC at St. We can think of (Ft,T - St) as a profit from the FX swap. ⋄ We get the same IRPT equation if we start the covered strategy by …

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