The paper 'How to Make a Geographical Arbitrage' is a great example of a financial and accounting assignment. Delbaen & Schachermayer defines arbitrage as the opportunity to buy a currency, asset, or financial instrument at a low price and then selling it immediately at higher prices at different markets. The corporate treasury is in a position to make geographical arbitrage profits from the difference in currencies of the two banks. By acting fast, the corporate treasury will make a geographical arbitrage of A$2,535.9256. To get this the firm will convert A$1,000,000 to euro by dividing it by A$1.1830/€ to become € 845308.5376.
These are Euros as offered by Barclays London. Then multiply € 845308.5376 by A$1.1860/€ to get A$1,002,535.9256 in the Australian dollar. The corporate treasury will as a result make A$1,002,535.9256 - A$1,000,000 = A$2,535.9256 from the arbitrage process. The firm, using one million Australian dollars, buy the euro at the lowest quoted price A$1.1830/€ as quoted by Barclays London. From the resultant amount, in form of euro, sell it into to Australian dollar at the highest quoted price A$1.1860/€ by Westpac Sydney. This will give the company an arbitrage profit.
To get the maximum arbitrage profit the corporate treasury must act very fast as these prices are subject to change very fast. It must operate speedily to exploit on the currency difference. Covered interest rate arbitrage entails investing in a foreign currency, for a short term that is covered by a forward contract for the purpose of selling the currency upon the maturity of the investment as Bjö rk (2004) explains. This arbitrage is credible when the interest rate differences are not reflected by the forward premium between the two countries as indicated by the formula for interest rate parity.
The interest rate parity provides that the forward premium should indicate the interest rate differences between the two countries (Japan and Australia). A call option presents Katya Berezovsky a right but not necessarily a requirement to buy the currency at a prearranged strike price before the expiry of the call option. She will buy the call option with hopes that the underlying currency rates will rise significantly well higher than the strike price for her to exercise the call option.
Arbitrage Risk and Post‐Earnings‐Announcement Drift, The Journal of Business, 77(4), 875-894.
Björk, T. (2004), Arbitrage theory in continuous time, Oxford university press. Mendenhall, R. R. (2004).
Brealey, R. A., Myers, S. C., & Allen, F., (2006), Corporate finance Boston et al.: McGraw-Hill/Irwin.
Caselli, F., & Feyrer, J., (2007), The marginal product of capital, The Quarterly Journal of Economics, 122(2), 535-568
Delbaen, F., & Schachermayer, W., (2006), The mathematics of arbitrage Berlin: Springer.