Speculative Profit: Speculative profit comes from the speculating that a currency would appreciate or depreciate (either due

to economic factors or the speculative attacks themselves or even both). If the speculation is correct, then the traders would make profits, however, if their speculation turns out to be wrong, they would then make losses. In our example, profit is made as follows. First, the trader sells short RM2.4 million ringgit at the initial exchange rate of 2.40 per dollar. This equals US$1 million and would be credited to his account. Assume now that the attack caused the ringgit to depreciate to RM3.80 per dollar. Now at this new exchange rate the RM2.4 million is worth only US$0.63 million[3]. Therefore, the trader closes his position by buying back the RM2.4 million at this new rate and makes a handsome profit of US$0.37 million (i.e. US$370,000!). Even though the trader makes a hefty speculative profit of about US$370,000, the profit does not end there. There is another profit to be made the arbitrage profit. Arbitrage Profit: Arbitrage profit is made from the mispricing or disequilibrium among the exchange rates. In our example, this disequilibrium happened when the ringgit exchange rate moved. Arbitrage profits are realized at a point in time unlike speculative profits that require a span of time. In the above example the arbitrage profit is made as below: Step 1: Borrow US$1 million[4] and exchange it into RM3.8 million (at the new prevailing exchange rate of RM3.80 per US dollar). Step 2: Exchange the RM3.8 million into S$2.533 million (at the exchange rate of RM1.50 per Singapore dollar) Step 3: Exchange the S$2.533 million into US$1.5833 million (at the exchange rate of S$1.60 per US dollar) Step 4: Return back the loan of US$1 million, and keep the remaining US$583,333 as arbitrage profit[5]. Hence the total speculative and arbitrage profits equal 370,000 + 583,333 = US$953,333. Note that for a transaction of US$1 million each in the speculative and arbitrage activities, the profit is almost a whopping US$1 million too! Currency traders, however, do not just trade in millions but rather in billions! Hence imagine the amount of profits they would be making!! As arbitrageurs make profit through their actions, the exchange rates between currencies would move until the arbitrage opportunity is eliminated. In our example since a profit is made by first exchanging US$ into ringgit, there would be a tendency for the ringgit to appreciate over the US dollar (or to fight back the attack). Similarly, the action of exchanging ringgit into Singapore dollar would make the Singapore dollar appreciate over the ringgit. The last transaction of changing the Singapore dollar back into the US dollar would cause the US dollar to appreciate over the Singapore dollar. Therefore, even though the speculators attacked only the ringgit, the Singapore dollar would appreciate over the ringgit and the US dollar would appreciate over the Singapore dollar until the arbitrage opportunity is eliminated. A final exchange rate as below would have eliminated such an arbitrage opportunity and would now form the new equilibrium exchange rate between the three currencies: An arbitrage profit, as shown above, can be made with any three currencies and need not be using only the ringgit, the US dollar and the Singapore dollar. Therefore, movements of all crosscurrency rates could be expected. Nonetheless, only three currencies are needed for making an arbitrage profit. It takes only three currencies to break equilibrium and make arbitrage possible. For this reason such an arbitrage is also called a triangular arbitrage[6].

Speculative and arbitrage profits using national currencies are made possible by the mere existence of numerous fiat currencies that are volatile in nature. The global fiat monetary system provides a fertile ground for speculation, manipulation and arbitrage in the foreign exchange market[7]. [1] But erroneously termed the Asian Miracle. [2] In this example we have ignored transaction costs. In practice, the buying and the selling rates for currencies would differ; the difference being the profit to the bank or money changer. Ignoring transaction costs, however, does not affect the illustration of this example. [3] In practice the speculators and arbitrageurs would not wait till the exchange rate moves this much in order to profit. Profits are realized when the exchange rate moves enough to cover transaction costs. [4] Since arbitrage is done at a point in time, one may borrow this US$1 million probably for just a few minutes within which the entire transaction could be completed, particularly if transactions are done on-line using computers. [5] Note that, in the example, the arbitrage transactions must be done clockwise starting from any of the currencies. This example starts from US$. If we had started using RM1million, the profit would have been RM583,333 instead. Transactions done anticlockwise would result in losses. Therefore, upfront one needs to determine the direction for making arbitrage profits clockwise or anti-clockwise. [6] If profit is made using four or more currencies, then all transactions except three are either redundant or they reduce the profit made. Mathematically, if all the cross exchange rates were placed in a matrix, equilibrium would imply the determinant of the matrix to equal zero. If the determinant does not equal zero, then it implies arbitrage opportunity exists somewhere between the currencies. [7] Back in the 1970s, the daily global volume of foreign exchange transactions was around $10$20 billion. By 2000, the average transaction was around $2 trillion! See Bernard Lietaer, The Future of Money, Century, 2001, p.312.

Stock Market Arbitrage

Arbitrage opportunities appear here and there, all the time in the financial markets. Pure 100% risk-free stock market arbitrage opportunities are hard to spot, however it is essential to understand how the markets offer this opportunity, and then apply similar principles on other trades, where theres very little risk, or theres no risk at all!

In both cases, with the 100% risk-free arbitrage trades and the extremely low risk/low reward trades, a stock investor and/or option trader has to look beyond the obvious and uncover the real opportunity. Looking beyond the obvious is important, because we cannot tell by just looking at a bunch numerical data if theres an arbitrage opportunity or not. Investing

in the very short stock market cycles means a small return, but the setups occur so frequently, as frequently as 3 times a day, therefore a 5% investment, repeated over 3 times daily can become a large return investment. Before we move to options and stocks, lets see how arbitrage works in sporting events, such as horse racing, consider a horse race and the betting market around it: By combining the best odds, from several different bookmakers, we have the following cases:

Can you figure out which of the two combinations of odds offers an opportunity for an arbitrage profit? The fact is that combination 1 loses money, even with the best distribution possible you would always lose 11.6%. Combination 2 however does offer an arbitrage opportunity, and to be exact, it makes 11% of profit, no matter which horse wins the race. I did use a formula to figure out if theres a profit margin or not, and I also need another formula to figure out how much money exactly I would have to bet on each selection, in order for my arbitrage equation to hold true.

Stock Market Arbitrage With Complete Protection

Its similar with stocks and stock options, there are so many numerical data, that are beyond an easy calculation, let alone a simple observation. Arbitrage is not about fooling one option broker, is simply about exploiting the whole system of brokers, who collectively appear to you as a riskless trading platform. That is, one trades risk is offset by another trades reward, both trades placed on the same underlying stock, at a different option broker or using a different kind of option trade!

Stock Arbitrage Strategy

Overbought Oversold: One common stock market arbitrage strategy is to spot a market, such as two highly correlated stock indices, or actual stocks that every now and then fall out of sync. If one of the stocks rises too much while the other is lagging behind, it is almost certain that sooner or later they will fall back in synch with each other again! So the trader sells the overbought stock, while at the same time he buys the lagging stock. The outcome of this is that the profit made on the winning trade will exceed the loss made on the losing trade. Stock market investing professionals and traders do this all the time, sometimes these opportunities may last only few minutes to a few hours, but they have the experience and techniques to place their trades simultaneously, thereby making risk free money. This stock market arbitrage strategy can be implemented using many instruments, but option traders do it differently, when they detect an overbought-oversold relationship between an option and the underlying stock itself! This once again is an overlooked profit opportunity, and it means

instant risk-less profit to the trader. Short term investing in the stock market like this, makes approximately 2% to 5% profit on the capital used, for example $50 on a $1,000 capital commitment
From Wikipedia, the free encyclopedia

FORWARD EXCHANGE RATE

Not to be confused with forward rate or forward price.

The forward exchange rate (also referred to as forward rate or forward price) is the rate at which a bank is willing to exchange one currency for another at some specified future date.[1] The forward exchange rate is a type of forward price. It is the exchange rate negotiated today between a bank and a client upon entering into a forward contract agreeing to buy or sell some amount of foreign currency at a future date.[2][3] The forward exchange rate is determined by the relationship among the spot exchange rate and differences in interest rates between two countries. Forward exchange rates have important theoretical implications in forecasting future spot exchange rates. Multinational corporations often use the forward market to hedge future payables or receivables denominated in a foreign currency against foreign exchange risk by using a forward contract to lock in a forward exchange rate. Hedging with forward contracts is typically used for larger transactions, while futures contracts are used for smaller transactions. This is due to the customization afforded to banks by forward contracts traded over-the-counter, versus the standardization of futures contracts which are traded on an exchange.[1] Banks typically quote forward rates for major currencies in maturities of 1, 3, 6, 9, or 12 months, however in some cases quotations for greater maturities are available up to 5 or 10 years.[2]

Contents
[hide] 1 Relation to covered interest rate parity 2 Forward premium or discount 3 Forecasting future spot exchange rates 3.1 Unbiasedness hypothesis

4 See also 5 References

[edit] Relation to covered interest rate parity

Covered interest rate parity is a no-arbitrage condition in foreign exchange markets which depends on the availability of the forward market. It can be rearranged to give the forward exchange rate as a function of the other variables. The forward exchange rate depends on three known variables: the spot exchange rate, the domestic interest rate, and the foreign interest rate.

This effectively means that the forward rate is the price of a forward contract, which derives its value from the pricing of spot contracts and the addition of information on available interest rates.[4] The following equation represents covered interest rate parity, a no-arbitrage condition under which investors eliminate exposure to exchange rate risk (unanticipated changes in exchange rates) with the use of a forward contract - the exchange rate risk is effectively covered. The reason for the no-arbitrage condition is that the dollar return on dollar deposits, 1+i$, is set equal to the dollar return on euro deposits, F/S(1+ic). If these two returns weren't equal, there would be a potential arbitrage opportunity in which an investor could borrow currency in the country with the lower interest rate, convert to the foreign currency at today's spot exchange rate, and invest in the foreign country with the higher interest rate. Investors will be indifferent to the interest rates on deposits in these countries due to the equilibrium resulting from the forward exchange rate.[4]

where
F is the forward exchange rate S is the current spot exchange rate i$ is the interest rate in the US ic is the interest rate in a foreign country or currency area (for this example, it is the interest rate available in the Eurozone)

This equation can be arranged such that it solves for the forward rate:

[edit] Forward premium or discount

The equilibrium that results from the relationship between forward and spot exchange rates within the context of covered interest rate parity is responsible for eliminating or correcting for market inefficiencies that would create potential for arbitrage profits. As such, arbitrage opportunities are fleeting. In order for this equilibrium to hold under differences in interest rates between two countries, the forward exchange rate must generally differ from the spot exchange rate, such that a noarbitrage condition is sustained. Therefore, the forward rate is said to contain a premium or discount, reflecting the interest rate differential between two countries. The following equations demonstrate how the forward premium or discount is calculated.[1][2] The forward exchange rate differs by a premium or discount of the spot exchange rate:

F = S(1 + P)
where
P is the premium (if positive) or discount (if negative)

The equation can be rearranged as follows to solve for the forward premium/discount:

In practice, forward premiums and discounts are quoted as annualized percentage deviations from the spot exchange rate, in which case it is necessary to account for the number of days to delivery as in the following example.[2]

where
N represents the maturity of a given forward exchange rate quote d represents the number of days to delivery

For example, to calculate the 6-month forward premium or discount for the euro versus the dollar deliverable in 30 days, given a spot rate quote of 1.2238 $/ and a 6-month forward rate quote of 1.2260 $/:

The resulting 0.021572 is positive, so one would say that the euro is trading at a 0.021572 or 2.16% premium against the dollar for delivery in 30 days. Conversely, if one were to work this example in euro terms rather than dollar terms, the perspective would be reversed and one would say that the dollar is trading at a discount against the euro.
Outright Rate
The exchange rate on an outright forward. An outright forward is a forward contract in which a party agrees to buy a currency from another party at some definite point in the future at a given exchange rate. This exchange rate is an outright rate.