Forex Articels

 

Forex Arbitrage

In the financial world the term arbitrage is mostly used with regard to currencies, stocks, bonds, derivatives, and commodities. Oftentimes there will be a difference between (various; several) markets prices. Profits may be made off of this circumstance. The term arbitrage refers to acts, in which this price difference is taken advantage of, and profits are made (from the difference between the prices; such profits are without a risk). One who takes upon himself/herself to participate in acts of arbitrage is commonly referred to as an “arbitrageur”.

Do not be confused: Arbitrage does not refer to the buying of a product from a certain market at a certain price at a certain point in time, and the selling of it at a different market at a different price (higher) at a future time. For arbitrage to be possible, the buying and selling must happen simultaneously. This is as to avoid changes in market prices from taking place before the transactions are completed. Arbitrage is not always possible, and in fact, at times, prices will not allow for a profit, in which case, the market is described as: arbitrage-free market, or it is claimed that there is an arbitrage equilibrium.

Following you will find an example that will illustrate the notion of arbitrage: (the numbers used below are arbitrary and do no correspond to the real market; furthermore, real life situations are never as simple as the example below).

• Let’s assume that in London: £1 = $2 = ¥300.
• Let’s assume that in Japan the exchange rates are: ¥300= $3= £1.5.
• Let’s assume to have converted ¥300 to $3 in Japan.
• Let’s assume to convert those $3 to ¥450 in London.
• This way we have made a profit of ¥150.
• What we have done in the above transaction is arbitrage.

There are some circumstances that would bring about the possibility of arbitrage, but before mentioning them, it should be stated that arbitrage is mostly possible with securities and financial products that are being traded electronically. The circumstances are: * Identical cash flow assets traded at different prices. * The same assets traded at different prices at different markets. * Assets that have known future prices but are not (today) traded at their future prices (at a risk-free interest rate).