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
