Currency arbitrage is the process of taking advantage of price differences between two or more currencies to make a profit. You can do this by buying a currency at a lower price in one country and selling it for more in another country. You can buy currencies from Saxo Bank.
Arbitration typically occurs when there is a difference in the exchange rate between two countries. For example, if the exchange rate for British pounds (GBP) to US dollars (USD) is 1.5 USD per GBP, but the exchange rate for Canadian dollars (CAD) to USD is only 1.2 USD per CAD, then an investor could buy GBP with CAD, and then sell them back for USD, making a profit of 0.8 CAD per GBP.
Many factors can affect the exchange rate between two currencies, including economic and political conditions, interest rates, and inflation.
How to use currency arbitrage
Spot arbitrage is the simplest form of currency arbitrage and involves buying and selling a currency immediately, or “on the spot.” For example, if the exchange rate for GBP to USD is 1.5 USD per GBP, but the exchange rate for CAD to USD is only 1.2 USD per CAD, then an investor could buy GBP with CAD, and then sell them back for USD, making a profit of 0.8 CAD per GBP.
You can do this by buying foreign currency at a bank or foreign exchange (FX) dealer or through a foreign exchange broker.
Forward contracts are contracts to buy or sell a certain amount of a given currency at a pre-established price on a specific date in the future. It allows investors to take advantage of expected changes in the exchange rate between two currencies.
For example, if an investor expects the GBP to the USD exchange rate to increase in the future, they could enter into a forward contract to buy GBP at 1.4 USD per GBP, with delivery set for six months in the future. If the exchange rate increases, the investor will make a profit on the contract. However, if the exchange rate falls instead, the investor could lose money.
Forward contracts can be entered into through banks or FX dealers.
Futures contracts are similar to forwarding contracts but are traded on a futures exchange. It allows investors to buy and sell contracts based on the current exchange rate without entering into a contract with a specific bank or FX dealer.
You can use futures contracts to bet on whether the exchange rate between two currencies will rise or fall and be traded through futures exchanges such as the Chicago Mercantile Exchange (CME) or the London Metal Exchange (LME).
Options contracts are agreements that give the buyer the right, but not the obligation, to purchase or sell a fixed amount of a given currency at a pre-established price on or before a specific date. Like futures contracts, You can trade options contracts through futures exchanges.
You can use options contracts to make money whether the exchange rate between two currencies rises or falls and can be used to protect an investor’s position if the exchange rate moves against them.
The carry trade is a strategy that involves borrowing money in a low-interest currency, such as Japanese yen (JPY), and investing it in a high-interest currency, such as Australian dollars (AUD). The goal of the carry trade is to earn the difference in interest rates between the two currencies.
For example, if an investor borrows JPY at 0.1% interest per year and invests it in AUD at 4% interest per year, they will earn 3.9% per year on their investment.
You can make carry trades through FX dealers or foreign exchange-based mutual funds or ETFs.
Arbitrage funds invest in various currencies, intending to profit from differences in the exchange rates between those currencies. These funds can be either actively managed or passively managed and can be bought and sold similarly to any other mutual fund or ETF.
Arbitrage funds can be used to profit from changes in the exchange rate between two currencies and changes in the interest rates of those currencies.