ABSTRACT
Arbitrage is a very common transaction in international currency markets. This chapter provides the financial tools required to identify and manage arbitrage opportunities. The practice of arbitrage can take any one of the three forms: locational, triangular, and covered interest. Locational arbitrage refers to profiting from the variance in spot quotations between two or more locations. Triangular arbitrage refers to the immediate repurchasing of a currency previously sold in a different location. Covered interest arbitrage refers to investing local funds in terms of a foreign currency at higher rates of return and without exchange rate risk. Covered interest arbitrage is convenient only if the rate of return of the foreign investment, measured in terms of the local currency, is higher than the domestic rate of return. To illustrate the covered interest arbitrage technique, it is assumed that a multinational corporation has $2.8 million in cash available to redeem a dollar payable in 90 days.
