In uncovered interest arbitrage transactions, the direction of capital flow is mainly determined by uncompensated spreads. If the interest rate in Britain is Iuk and the interest rate in the United States is Ius, and the spread of UD is not offset, there are:
UD = UK-UK
If luk> luce, UD>；; 0, capital flows from the United States to Britain, and Americans have to convert dollars into pounds and deposit them in Britain or buy British bonds to get more interest. The size of arbitrage profit is determined by the spread between the two and the fluctuation of spot exchange rate. With the spot exchange rate unchanged, the greater the interest rate difference between the two countries, the greater the profit of the arbitrageur. Under the condition that the interest rate difference between the two countries remains unchanged, the higher the interest rate, the greater the profit of the arbitrageur; When the currency with high interest rate depreciates, the profit of the arbitrageur decreases, even to zero or negative.
Let's assume that the annual interest rate in Britain is luk= 10% and that in the United States is lus=4%. The spot exchange rate of the pound at the beginning of the year is equal to the spot exchange rate at the end of the year, and the exchange rate of the pound has not changed during 1 year; 1 = 2.80 USD, and the principal of American arbitrageur is 1000 USD. Arbitrators converted dollars into pounds at the beginning of the year and deposited them in British banks;
$ 1000÷$2.80/￡=￡357
The interest earned after 1 year is:
￡357× 10%=￡35.7
It is equivalent to 100 USD (35.7×2.80 GBP /= 100 USD), which is the gross profit of the arbitrageur. If the arbitrageur deposits $65,438+0,000 in the Bank of America without arbitrage, the interest he gets is:
65438 USD +0000×4% = 40 USD, which is the opportunity cost of arbitrage. Therefore, the net profit of the arbitrageur is $60 (100-40).
In fact, 1 year, the spot exchange rate of the pound will not stay at the level of $2.8/. If the spot exchange rate of the pound at the end of the year is $2.4/~, due to the devaluation of the pound, 35.7 pounds can only be converted into $85, and the net profit will be reduced from $60 to $45. This shows that when the arbitrageurs bought the spot pound at the beginning of the year, they did not sell the 1 year forward pound at a certain exchange rate, and assumed the risk of exchange rate changes, resulting in a net loss of 15 USD. From this example, it can be seen that the greater the depreciation of the pound, the greater the loss of the arbitrageur. Of course, if the spot exchange rate of the pound at the end of the year is USD 3/~ USD, the arbitrageur will be very lucky, and his net profit will reach USD 67 [($35.7×3)= 107]. Exchange rate changes will also bring risks to arbitrageurs. In order to avoid this risk, arbitrageurs convert low-interest currencies into high-interest currencies at the spot exchange rate, and also convert high-interest currencies into low-interest currencies at the forward exchange rate, which is called carry arbitrage. Take Britain and America for example. If the interest rate in the United States is lower than that in Britain, Americans are willing to convert dollars into pounds at the spot exchange rate and deposit them in British banks. In this way, the American demand for pounds has increased. The demand for sterling has increased, and the spot exchange rate of sterling should increase if other factors remain unchanged. On the other hand, in order to avoid the risk of exchange rate changes, arbitrageurs all sign contracts to sell forward pounds at the forward exchange rate, which increases the supply of forward pounds. The supply of forward pounds will increase, and the exchange rate of forward pounds will fall when other factors remain unchanged. According to the experience of foreign exchange market, westerners come to the conclusion that the spot exchange rate of currencies in countries with higher interest rates is on the rise and the forward exchange rate is on the decline. According to this law, the direction of capital flow depends not only on the interest rate difference between the two countries, but also on the interest rate difference between the two countries and the forward premium rate or discount rate of the national currency with high interest rate. If the offset price difference is CD and the discount rate or premium of the pound is F%, there are:
Cd = iuk-ius ten f
If UK interest rate Iuk= 10%, US interest rate Ius=4%, forward pound discount rate F =-3%, CD = 10%-4%-3% = 3%) 0, then capital will flow from the US to the UK. Because arbitrageurs believe that although the forward pound discount reduces their profits, there are still profits to be made. If the discount rate of forward pound is f =-8%, other conditions being the same, CD = 10%-4%-8% =-2% (0, then capital will flow from Britain to the United States. Because arbitrageurs think that the discount rate of forward pound is too high, which not only reduces their profits, but also makes their profits negative. The British, on the other hand, are willing to convert pounds into dollars at the spot exchange rate and dollars into pounds at the forward exchange rate, so that capital can flow from Britain to the United States.
Next, give another example to illustrate the actual situation of carry arbitrage. Suppose the principal of the arbitrageur is $65,438+0,000, Iuk= 10%, Ius=4%, the spot exchange rate of the pound is $2.8/%,and the forward exchange rate of the pound is $2.73/%. At the beginning of the year, the arbitrator converted US dollars into British pounds and deposited them in the Bank of England;
$ 1000÷$2.8/￡=￡357
The interest earned after 1 year is:
￡357× 10%=￡35.7
According to the forward exchange rate of the contract signed at that time, it is equivalent to 97 dollars (~ 35.7×2.73 dollars/~), which is the gross profit of the arbitrageur. If the opportunity cost of arbitrage is deducted, it will be 40 dollars (65438 dollars +0000×4%), and the net profit of the arbitrageur will be 57 dollars (~ 97 dollars). This example shows that the arbitrageur sells the spot pound at a higher forward pound exchange rate while buying the spot pound, so as to avoid the losses caused by the sharp drop of the pound exchange rate. After 1 year, the spot pound exchange rate is $2.4/%,and the arbitrageur is still $2.73/%.
Arbitrage activities not only make arbitrageurs profit, but also play a role in spontaneously regulating capital flows objectively. The high interest rate in a country means that the capital there is scarce and badly needed. The interest rate in a country is very low. This means that there is enough capital there. Arbitrage activities are motivated by the pursuit of profit, which makes capital flow from rich places to scarce places and makes capital play a more effective role. Through arbitrage activities, capital flows to countries with higher interest rates, where capital increases and interest rates will drop spontaneously; Capital keeps flowing out of countries with low interest rates. If capital decreases, interest rates will increase spontaneously. Arbitrage activities eventually make interest rates in different countries tend to be equal.
The imbalance between foreign exchange supply and demand in several important international financial markets provides opportunities for foreign exchange transactions such as hedging, speculation, swaps, arbitrage and arbitrage, which in turn can spontaneously balance the foreign exchange supply and demand in various financial markets around the world. Equilibrium is always relative, and imbalance is absolute and long-term. Therefore, hedging, speculation, swap, arbitrage and arbitrage are essential transactions in the foreign exchange market. Without these transactions, the foreign exchange market will shrink, and it will not play a role in regulating funds or purchasing power.