Reflection Paper on Outsourcing
Submitted by:
Md.Tasin Afridi (19104110)
Md. Sazid Hossain (19104100)
Shadat Hossain Shakil (19104002)
Nafees Imtiaz Khan (18204061)
International Financial Management (FIN425)
Section: 01
Group- 09
Spring 2022
Submitted to
Samina Haque
Senior Lecturer, BRAC Business School
BRAC University
18th April, 2022
Questionnaires1.What is arbitrage and how many types of arbitrage there are?
2. How can you gain money from local,triangular and covered interest arbitrage?
3. What is realignment and how does it work?
4. Does Arbitrage exist in trading? Give a real life example.
5.How arbitrage stimulates investors to invest in it?
6.what are the major drawbacks regarding arbitrage?
In this world of globalization there are very few attributes available for riskless gain from
currencies in the global market. Arbitrage has become the most common approach for a firm to
minimize its costs and gain from the currency discrepancy overseas. There are some stumbling
blocks on arbitrage nevertheless, arbitrage is an exemplary market to invest in.
Arbitrage can create a chance to make profit from the different quoted price. There are three
types of Arbitrage they are- (i) Locational arbitrage, (ii) Triangular arbitrage, (iii) Covered
interest arbitrage. To begin with, locational arbitrage is a procedure in which various banks have
different currency rates. Banks usually provide foreign exchange facilities at the same quoted
price, but demand and supply factors for a given currency can differ between banks. As a result,
currency discrepancy arises. Investors can capitalize on a discrepancy in quoted price by making
riskless profit. For instance, South bank British pound bid price is $1.50 and ask price $1.52
while west bank bid and ask price is $1.53/$1.55. So, the ask price in the south bank is less than
the west bank and the bid price of the west bank is higher than the south bank bid price. As a
result the difference between bid and ask and bid price is 0.01 so investors will go to the south
bank to purchase pounds and sell it to the west bank. Locational arbitrage gain depends on two
things: one is discrepancy of quotation and another one is the amount of money. In locational
arbitrage, the realignment process occurs when a bank's one currency demand increases and
another bank's supply increases for that currency. In the realignment process it changes the
quotation price to remove the discrepancy of the quotation price. As a result, investors can not do
locational arbitrage anymore until a new discrepancy occurs in the quotation price. Secondly,
Triangular arbitrage is the discrepancy of cross exchange rate. Here, cross exchange rate is
basically the relationship between two currencies that differ from one another's base currency. In
the triangular arbitrage investors have to identify the cross exchange rate then investors have to
compare it with the base quoted price. If the quoted price of that currency is lower than the cross
exchange rate then investors will buy that currency; otherwise investors will buy the opposite
currency. For example, the British pound in Malaysian ringgit is $ 8.10 and cross exchange rate
is $8.00. So, the British pound quoted price is higher than its cross exchange rate. As a result
investors will buy the British pound and they will gain from this difference in quoted price and
cross exchange rate. Finally, whenever there is an interest rate differential, traders can engage in
covered interest arbitrage. Covered interest arbitrage is the technique of profiting from interest
rate differentials between two nations while also hedging the currency risk by using a forward
contract. There are two parts in covered interest arbitrage: one is to capitalize the money by
interest arbitrage and the other is hedging the risk by using a forward contract. For example, the
60 days interest rate in the United States is 3% and the United Kingdom interest rate is 5%.
Investor wants to invest $1000 where the spot rate of the pound is $1.58 and forward rate of the
pound is $1.59. So, the interest rate in the UK is higher than the US interest rate and the forward
rate of the pound is also higher than the spot rate. Now, Investor will convert his/her $1000 to
£632. After getting the interest rate, the investor will get £663 and convert it to US dollars by
using the forward rate. As a result, investors will gain $5.41% from the contract. Whenever
demand and supply for a currency increases a lot then the forward rate of
that currency
decreases to offset the covered interest arbitrage.So, Covered interest arbitrage refers to investors
who will almost certainly earn a higher return on their investment than they could get at home.
In order to benefit from a price difference between two markets, arbitrage is an investing
technique in which an investor buys and sells an asset in both markets at the same time to take
advantage of the difference. Despite the fact that pricing variations are often tiny and short-lived,
the profits may be substantial when compounded by a large number of transactions. Arbitrage is
a strategy used often by hedge funds and other skilled investors to get an advantage over the
market. A variety of arbitrage strategies are available. These include pure arbitrage, merger
arbitrage, and convertible arbitrage, to name a few. While global macro is a kind of investment
strategy that is connected to arbitrage, it is regarded as a distinct method since it relates to trading
in differences in economic conditions across various nations. Even though this is a
straightforward method, few if any investment funds use it exclusively. This is explained by the
difficulty of utilizing a temporary circumstance. With the advent of computerized trading, which
can execute trade orders in milliseconds, mispriced asset disparities are now rare. In this respect,
faster trading has boosted market efficiency. Moreover, the price differential between equivalent
assets is usually less than the transaction costs of an arbitrage deal. This practically cancels
arbitrage. Large financial organizations often exploit arbitrage since it takes enormous resources
to find and execute deals. To discover analogous assets, they often employ complicated financial
structures such as derivative contracts and other synthetic products. Margin trading is common in
derivative trading, requiring substantial amounts of capital to make contracts. The subjective
worth of paintings tends to provide arbitrage possibilities. For example, a painter's work may be
inexpensive in one nation but highly valued in another. An art dealer might arbitrage by
purchasing cheaper artworks and selling them in a more expensive nation. Suppose a stock of
Company XY is trading at $40 on the LSE. The identical stock is trading for $40.80 on the New
York Stock Exchange, according to an arbitrageur (NYSE). To make a profit of $0.80 per share,
the trader might simply purchase the stock on the LSE and sell it on the New York Stock
Exchange. Due to the fact that our investor is likely not the only one who has noticed the price
discrepancy and the potential for a profit-free deal (in fact, hedge funds and sophisticated
arbitrage software would probably be in the trade immediately as the price difference reveals).
London's lower-priced stock would rise in price as a result of greater demand, while New York's
higher-priced stock would fall as a result of increased supply. Arbitrage possibilities involving
currencies are also common. Currency arbitrage is a common method of profiting from currency
exchange rate disparities since currencies are not exchanged on centralized exchanges but rather
on over-the-counter marketplaces worldwide.
There are lots of debates around arbitrage in terms of its feasibility and its regulation. From our
approach, arbitrage makes a dynamic change in the global financial market. Apart from its profit
making,it assists global financial markets to increase their efficiency by the traders. As arbitrage
takes place by buying and selling a narrow price difference on spot and forward market between
currencies,it resolves inefficiencies in the market’s pricing and most importantly it drives
liquidities into the market.In arbitrage it mostly depended on supply and the demand for the
currency in the financial market. As a result, it makes a balance between supply and demand of
the currencies as well as it assists currencies towards a standard price.Moreover,arbitrage helps
MNCs to reduce their transaction cost.As their transaction placed on a bulk amount, locational
arbitrage reduce their cost by reducing the difference between bank quotations on spot market.In
terms of covered interest arbitrage it ensures the forward rate to be properly priced. In
consequence, MNC’s could avoid excessive transaction cost.Furthermore, we think it makes
markets more liquid as it invites institutional participation and the use of sophisticated
technology. In a nutshell, we believe it makes market efficient, smoother and safer which
stimulates investors to invest on it.Despite of it’s riskless gain and other attributes,it also has
some drawbacks to talk about.We think,all of the locational, triangular and covered arbitrages
ensures and drives the quoted spot and forward rate towards efficiency. Consequently, the
discrepancy might
be eliminated from the market which will be triggered to prevent
arbitrage.Besides,the gain from the arbitrage depends on the quantity of investment as it earns a
minimum number of percentage from the global financial market. As we mentioned above about
the possible elimination of discrepancy,the investors will not find it profitable.Additionally,
effective arbitrage must execute a large number of deals, their expense ratios can be extremely
high. Arbitrage may be a very profitable investment, especially when market volatility is high.
However,this will disallow investors to profit from market volatility as the costs aren’t efficient.
Lastly, we think people are not calculative enough sometimes and estimates some wrong gains
without considering it’s costs and ignores taxation over it. From our speculation,arbitrage is
becoming more and more popular day by day in our country. The recent addition of ‘TradeX’ by
Lankabangla paves a way to do arbitrage more swiftly in Bangladesh. To sum up, investors buy
and sell the same assets at the same time and pocket the price difference as a profit. Arbitrage
makes the market efficient, smoother and safer. The gain from the arbitrage depends on the
quantity of investment as it earns a minimum percentage from the global financial market.
Reference:
1.https://www.investopedia.com/terms/forex/f/forex-arbritrage.asp
2.https://www.letslearnfinance.com/arbitrage-advantages-and-disadvantages.html
3.https://www.newworldencyclopedia.org/entry/Arbitrage#Conditions_of_arbitrage