7 - International Arbitrage and Interest Rate Parity

_________ is defined as capitalizing on a discrepancy in quoted prices by making a riskless profit.

arbitrage

_________ is when you buy in one market and simultaneously sell in another market. The profit is from the temporary difference in price in the two markets. This is considered riskless profit for the investor.

arbitrage

__________ will cause prices to realign

arbitrage

Covered Interest Arbitrage: Investor must account for the effects of the spread between the _________ and of the spread between ________.

bid and ask quotes, deposit and loan rates

To achieve profits from this strategy the __________ of one bank must be higher than the ask price of another bank.

bid price

Transaction costs (________) can reduce or even eliminate the gains from triangular arbitrage.

bid/ask spread

When market forces cause interest rates and exchange rates to adjust such that __________ is no longer feasible, the result is an equilibrium state known as interest rate parity

covered interest arbitrage

_________ is defined as the process of capitalizing on the interest rate differential between two countries while covering your exchange rate risk with a forward contract.

covered interest arbitrage

Triangular arbitrage involves currency transactions in the spot market to capitalize on discrepancies in _______________ between 2 currencies

cross exchange rates

Recall that when the forward rate is less than the spot rate, this implies that the forward rate exhibits a _______.

discount

Realignment due to triangular arbitrage forces _________ back into equilibrium.

exchange rates

The threat of locational arbitrage ensures that quoted ________ are similar across banks in different locations. The threat of triangular arbitrage ensures that ________ are properly set. The threat of covered interest arbitrage ensures that ________ are properly set. Any discrepancy will trigger arbitrage, which should eliminate the discrepancy.

exchange rates, cross exchange rates, forward exchange rates

Covered Interest Arbitrage Realignment is focused on the ________, which is likely to experience most if not all of the adjustment needed to achieve realignment.

forward rate

Covered interest arbitrage ensures that the ________ is properly priced.

forward rate

In interest rate parity equilibrium, the ________ differs from the spot rate by a sufficient amount to offset the interest rate differentials between two countries.

forward rate

Covered interest arbitrage is defined as the process of capitalizing on the __________ between 2 countries while covering your __________ with a __________

interest rate differential, exchange rate risk, forward contract

In interest rate parity equilibrium, the forward rate differs from the spot rate by a sufficient amount to offset the __________ between two countries.

interest rate differentials

When market forces cause interest rates and exchange rates to adjust such that covered interest arbitrage is no longer feasible, the result is an equilibrium state known as ___________

interest rate parity

When market forces cause _____ and _____ to adjust such that covered interest arbitrage is no longer feasible, the result is an equilibrium state known as interest rate parity

interest rates, exchange rates

Realignment due to _________ drives prices to adjust in different locations so as to eliminate discrepancies.

locational arbitrage

3 forms of arbitrage

locational, triangular, covered interest

The threat of _________ arbitrage ensures that quoted exchange rates are similar across banks in different locations. The threat of _________ arbitrage ensures that cross exchange rates are properly set. The threat of _________ arbitrage ensures that forward exchange rates are properly set. Any discrepancy will trigger arbitrage, which should eliminate the discrepancy.

locational, triangular, covered interest

Realignment due to covered interest arbitrage causes __________.

market realignment

Realignment due to locational arbitrage drives ________ to adjust in different locations so as to eliminate discrepancies.

prices

Arbitrage is when you buy in one market and simultaneously sell in another market. The profit is from the temporary difference in price in the two markets. This is considered _________ for the investor.

riskless profit

Locational arbitrage limits the differences in a ________ quotation across locations

spot exchange rate

Realignment due to _________ forces exchange rates back into equilibrium.

triangular arbitrage

_____________ is defined as currency transactions in the spot market to capitalize on discrepancies in the cross exchange rates between two currencies.

triangular arbitrage

The U.S. dollar is the __________, meaning it is actively used in many international financial transactions around the world

vehicle currency