MBA (General)IV – Semester, International Business Unit 1
Definition of Currency Arbitrage in Spot Market and Speculation in the Spot Market
With fast development in the telecommunication system, rates are expected to be uniform in different foreign exchange markets.
Currency Arbitrage
in Spot Market
With fast
development in the telecommunication system, rates are expected to be uniform in different foreign exchange markets.
Nevertheless, inconsistency exists
at times. The arbitrageurs take advantage of the inconsistency and garner profits by
buying and selling of currencies.
They buy a particular currency at cheaper rate in one market and sell it at a higher rate in the other. This
process is known as currency arbitrage. The process influences
the demand for, and supply of, the particular currency in the two markets which leads ultimately to removal of inconsistency in the value of currencies
in two markets.
The arbitrageurs will buy the dollar in New
York and sell it in London making a profit of $ 1.9800 – 1.9710 = $ 0.009 pound sterling.
Speculation in the Spot Market
Speculation in
the spot market occurs when the speculator anticipates a change in the value of a currency,
especially an appreciation in the value of foreign
currency. Suppose the exchange rate today is ` 49/US
$, the speculator anticipates this rate to become ` 50/ US$ within the coming three
months. Under these
circumstances, he will buy US $ 1,000
for ` 49,000 and hold the amount for three
months, although he is not committed to this par- ticular time horizon. When the target exchange rate is reached,
he will sell US $ 1,000 at the new exchange rate that is at ` 50 per dollar and earn a profit of ` 50,000
– 49,000 = ` 1,000.
