Answer :
Arbitrage is a financial strategy that exploits price differences in different markets for the same asset. If you're dealing with the foreign exchange market and the future price of the Australian dollar to U.S. dollar ([tex]A/[/tex]) is given as 1.69, here is how you might consider an arbitrage opportunity:
Identify Mismatches:
- You first need to find a market where there might be a price mismatch. Check if the spot rate (current exchange rate) in the foreign exchange market differs from this futures price.
Calculate the Arbitrage Opportunity:
- Let's say the current spot rate is 1.65 A[tex]/[/tex].
- You can propose arbitrage by selling A[tex]in the futures market at 1.69 and buying A[/tex] in the spot market at 1.65.
Executing the Arbitrage:
- Buy in the Spot Market: Purchase A[tex]using[/tex] at a rate of 1.65. For example, you buy A$1,000 for $606.06 ([tex]\frac{1000}{1.65}[/tex]).
- Sell in the Futures Market: Sell A$1,000 in the futures market at the rate of 1.69. This would yield you $591.72 ([tex]\frac{1000}{1.69}[/tex]).
Calculate Profit:
- The difference between what you paid in the spot market and what you sold for in the futures market is your profit. In this case, it's $14.34 ([tex]606.06 - 591.72[/tex]).
Risk Considerations:
- Keep in mind, this strategy assumes no transaction costs and that you can actually conduct these transactions at the given rates. Also, market prices can fluctuate, potentially eroding any potential profit.
This simple example shows how you can profit from the differences in exchange rates across different market conditions. It's important to also consider the risks and ensure such opportunities actually exist in practice before proceeding with arbitrage transactions.
