Question

State the role of arbitrageurs in foreign exchange market

Answer 1

Definition: Arbitrage is the process of a simultaneous sale and purchase of currencies in two or more foreign exchange markets with an objective to make profits by capitalizing on the exchange-rate differentials in various markets.

The importance of arbitrage lies in its ability to correspond foreign exchange rates in all the major foreign exchange markets. The arbitraging involves the transfer of foreign exchange from the market with a lower exchange rate to the market with a higher exchange rate. Hence, arbitraging equates the demand for foreign exchange with its supply, thereby acting as a stabilizing factor in the exchange markets.

The arbitrage opportunity can be availed only where the foreign exchange is free from controls, and if any, controls should be of limited significance. If the sale and purchase of foreign exchange are under severe control and regulation, then the arbitrage is not possible. Practically, the arbitrage opportunity exists for a very brief period since in the mature markets the most of the trading has been taken by the algorithm-based trading (a trading system that relies heavily on mathematical formulas and computer programs to determine the trading strategies). These algorithm-based trading are quick to spot and is quite easy for a trader to keep track.

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Answer 2

Hey mate ! Here is your answer .


* Arbitrage in itself is a trade that profits by exploiting the price differences of identical or similar financial instruments on different markets or in various forms.

So, with forex arbitrage, foreign exchange traders acquire currency pairs to exploit any short-term pricing inefficiency between them.