FINC 321 Study Guide - Final Guide: Exchange Rate, Interest Rate Parity, Foreign Exchange Risk
Document Summary
Inflation makes currency week; one option is to raise interest rates. Determinants of exchange rates: demand and supply perspectives, ole of government, role of interest rates, role of prices. Arbitrage: can be loosely defined as capitalizing on a discrepancy in quoted prices. Often, the funds invested are not tied up and no risk is involved. Thus arbitrage can be defined as making risk-less profits. The process of arbitrage ensures that prices will adjust quickly to their equilibrium level. In an efficient market, arbitrage opportunities don"t exist for too long. The three types of arbitrage: locational arbitrage, triangular arbitrage, covered interest arbitrage, locational arbitrage is possible when a bank"s buying price (bid price) is higher than another bank"s selling price (ask price) for the same currency. Locational arbitrage ensures that quoted exchange rates are similar across banks in different locations: triangular arbitrage is possible when a cross exchange rate quote differs from the rate calculated from spot rates.
