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Chapter 7

Q. 7.ST.4

Explain in general terms how various forms of arbitrage can remove any discrepancies in the pricing of currencies.

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If there is a discrepancy in the pricing of a currency, one may capitalize on it by using the various forms of arbitrage described in the chapter. As arbitrage occurs, the exchange rates will be pushed toward their appropriate levels because arbitrageurs will buy an underpriced currency in the foreign exchange market (increase in demand for currency places upward pressure on its value) and will sell an overpriced currency in the foreign exchange market (increase in the supply of currency for sale places downward pressure on its value).