ABSTRACT
Government action can influence the size and direction of arbitrage flows within the deposit/swap market triangle. Deposits held with the national banking system by foreigners have remained freely convertible. French franc deposits held by domestic residents were convertible only for trade purposes. Banks would not be permitted any scope to arbitrage between the domestic franc deposit market and the swap market. Blockages to arbitrage between the spot and forward markets enhance the power of the central bank to influence the spot exchange rate of the franc by intervening in the spot exchange market. This chapter discusses the restrictions on borrowing domestic deposits for the purpose of arbitrage in the deposit/swap market triangle, and how these restrictions may be buttressed by placing obstacles in the way of indirect arbitrage. The effect of swap intervention on exchange rates and interest rates differs according to whether arbitrage in the domestic deposit/foreign currency deposit/swap market triangle is permitted freely or subject to restriction.
