I remember one of the questions was about gold and what the process was for making a profit by arbitrage. I can get how to figure out if it is overpriced or underpiced in the forward market. What I can’t figure out is what to do next. Especially with currency. I never know which market to borrow money and which to lend money. I just can’t keep any of it straight?! Anyone else have this problem or an intuitive way to keep this straight?
1+ Rd > 1 + Rf * F/S Rd- Risk free Domestic rate Rf- Foreign rate F- Forward S- Spot rare it left side is greater then borrow foreign and invest in domestic country and if it is smaller then borrow domestic and invest in foreign.
remeber the answer? was it C?
with currency, i always think this way, and i will use an example…lets say 1.95 $/L…a pound costs $1.95…if i figured out the forward stuff and the forward equals 1.90, but is trading 1.93 then clearly the forward is clearly trading high or rich or overpriced compared to where the actual forward should be and thus where the spot is…so i would want to buy the spot and sell the forward…and i think you agree. so, this is the answer…if i buy the spot, i am paying 1.95 dollars, so dollars are leaving my hands, and i am getting one pound, which comes into my hands…i can now invest that pound for the prevailing rate. And since i gave dollars away, i will probably need to borrow the dollars at the prevailing rate, and pay them back when i unwind. So, my trick, which isn’t much of a trick, is that once i determine the price i want to buy, $1.95 in the example, i know that means the money is leaving my account and the other kind is coming in. don’t know whether that helps, but once i got this straight all these Qs became easy.
richsg21 Wrote: ------------------------------------------------------- > remeber the answer? was it C? dude put the options. I dont think anybody would remember was it A, B or C
I do something similar to petetini. I didn’t memorize any arbitrage formulas, nor did I memorize any currecy conversion formulas. Just remember that it’s a zero sum game. Choose a side at the beginning and “borrow” at the spot, invest, see what your investment made and how much you owe on your loan. If you owe more at the end than you made, then the answer is the opposite of what you did. If you work a few examples like that it makes perfect sense and you’ll never get stuck again.
Thanks, that does help. I barely remember the question. By the time I went back to look at it my brain was pretty much shutdown due to exhaustion.
Buy low and sell high.
borrow in US.convert to currency B, sell currency B forward to lock in the favorable rate
“Buy low and sell high.” This is really the key item to remember. If you can find the value of both sides of the instrument then you want to buy/borrow the cheap side and sell/loan the expensive side