Organization of the Foreign Exchange Market
The significance of a foreign exchange market can hardly be underrated – the specified institution helps maintain the purchasing power of participants operating in different currencies high. The structure thereof, however, is rather basic. As a rule, interbank, spot, and forward markets are identified in the given environment. While interbank markets serve the primary purpose of currency transfer and are used for transactions worldwide, spot markets imply an immediate delivery of the currency traded. Finally, in forwarding markets, the delivery of currencies is postponed.
Spot and Forward Markets: Difference
Although the spot and the forward markets are both integral parts of the Foreign exchange market, there is a basic feature thereof that sets the two apart. Particularly, the speed of exchange and the delivery of the end product needs to be mentioned as the primary feature that helps draw the line between the two. While the spot market implies an immediate action and the subsequent retrieval of the currency, the forward market suggests that the settlement date should be set in the future (Shapiro 250).
Profitable Currency Arbitrage Opportunities
The currency market provides several opportunities for arbitrage and related operations. It should be noted, though that the specified opportunities and the efficacy of the Foreign Exchange Market are in inverse proportion to each other. Therefore, locating the existing arbitrage solutions may become rather complicated for a member of the designated environment. Therefore, a dilemma is created. By locating the opportunities for appreciation and depreciation of a specific currency in the environment of the corresponding states, one is likely to carry out a set of transactions that will ultimately end up in a profit.
Profits Associated: Calculation
To calculate the profits that the above transactions may trigger, one should consider the concept of cross rates. Specifically, the formula suggested by Shapiro (261) should be viewed as the primary tool for carrying out the analysis. For instance, when trading Korean Won for Chinese Yuan in India, one will have to consider the bid rate for the Korean Won, the ask rate for Chinese Yuan, and the ask cross rate for the Indian Rupee. Therefore, by buying Indian rupees for Korean Won and then trading them for Chinese Yuan in India, one will be able to retrieve the following outcome:
Therefore, the ask cross rate for the Indian Rupee will equal:
Therefore, the ask cross rate for an Indian Rupee will make 170.45.
Forward exchange contracts are known for their properties of hedging risks by providing an opportunity to locate the possible outcomes of specific actions to be taken for the period of three days. As a result, the environment, in which a company operates, becomes considerably less threatening in terms of financial risks. Since the spot rate is above the forward discount, at which currencies are traded in the designated environment, the owner of the foreign currency is capable of trading it in the target market rather successfully by retrieving a certain amount of profit.
Among the users of forwarding contracts, the companies willing to wait until an impressive product can be retrieved should be named these companies have the time to wait until the debt matures. Afterward, they collect the financial reward.
Works Cited
Shapiro, Alan S. Multinational Financial Management. New York, NY: Allyn and Bacon, 1982. Print.