Question

Let's go back to your rich long lost uncle who passed away and left you $50,000. Do you think you could make good investments by exchanging foreign currencies? How does arbitrage figure into your decision making? Would your foreign exchange strategy be long-term or short-term?

Answer 1

The amount of $50000 can be used for a good investment, by exchanging it to the other currencies. The $50000 fund will be exchanged into that currency, whose domestic market, is going to offer a higher interest rate. It means that over a period of time after the investments, the domestic currency will appreciate. It will give me higher return. Afterwards, again, it will be invested into another currency.

Arbitrage comes into the investment due to the presence of cross rate and it will help gain higher value upon the investment. For example, Funds in USD will be converted into the Swiss Frank. Then, funds in Swiss frank will be converted into the Euros. Finally, Euros will be converted into the USD. Due to arbitrage, the value of funds in US dollar,will be more than $50000.

Here, foreign exchange strategy will be short term, as a market will absorb the scope of arbitrage with its efficiency in the long period of time.