FX Arbitrage Flashcards
Give the general assessment of FX market
Always open; largest and most efficient asset clas; largest traded volume; very liquid.
Name instruments on the FX market
Spot, Forward, Futures, Options
How does the FX market work?
Mostly OTC (through brokers, not exchanges). There are no brokerage fees, just bid-ask.
How does the volatility smile in FX works?
It is not skewed, the upside of one is the downside of another
Can you assess the fundamental value of a currency?
Not really, very hard to do.
Need to weigh in factors such as:
Gold/FX reserves
GDP
Interest Rates
Inflation
Deficit
Demand for a countries assets
Usually to circumvent the problem of fundamental value in a currency, what is done?
Benchmark against historical “fair” value
What is the most common type of arbitrage explored in FX?
Triangle arbitrage
Types of situations that lead to triangular arbitrage?
Conjunctural (FWD prices during crises)
Structural (Carry)
Are triangle arbitrage opportunities easy to implement?
No, they are rare, fast and hard to implement in OTC markets
What is the Carry arbitrage? (FX)
Exchange currency for higher yielding currency, collect rates, and then exchange back.
Why does Carry arbitrage not work in FX?
Interest rate spread is priced into the forward
Are forwards good estimators of future spots? Why?
No. High yielding currencies do not devalue as much as implied by the forward.
Does FX Carry actually exist?
Yes, although it’s very crowded and thus very volatile
FX Business Hours:
Currencies tend to devalue during their home market opening hours. Explanation: Probably due to hedgers immunizing their FX risk during trading hours.
With what assets can you hedge FX risk?
Forward, future, options. Natural hedging.
