Definition of Currency arbitrage

Currency arbitrage

Taking advantage of divergences in exchange rates in different money markets by
buying a currency in one market and selling it in another market.

Arbitrage

The simultaneous buying and selling of a security at two different prices in two different markets,
resulting in profits without risk. Perfectly efficient markets present no arbitrage opportunities. Perfectly
efficient markets seldom exist.

Arbitrage Pricing Theory (APT)

An alternative model to the capital asset pricing model developed by
Stephen Ross and based purely on arbitrage arguments.

Arbitrage-free option-pricing models

Yield curve option-pricing models.

Arbitrageurs

People who search for and exploit arbitrage opportunities.

Asian currency units (ACUs)

Dollar deposits held in Singapore or other Asian centers.

Blocked currency

A currency that is not freely convertible to other currencies due to exchange controls.

Covered interest arbitrage

A portfolio manager invests dollars in an instrument denominated in a foreign
currency and hedges his resulting foreign exchange risk by selling the proceeds of the investment forward for
dollars.

Currency

Money.

Currency basket

The value of a portfolio of specific amounts of individual currencies, used as the basis for
setting the market value of another currency. It is also referred to as a currency cocktail.

Currency future

A financial future contract for the delivery of a specified foreign currency.

Currency option

An option to buy or sell a foreign currency.

Currency risk

Related: Exchange rate risk

Currency risk sharing

An agreement by the parties to a transaction to share the currency risk associated with
the transaction. The arrangement involves a customized hedge contract embedded in the underlying
transaction.

Currency selection

Asset allocation in which the investor chooses among investments denominated in
different currencies.

Currency swap

An agreement to swap a series of specified payment obligations denominated in one currency
for a series of specified payment obligations denominated in a different currency.

Devaluation A decrease in the spot price of the currency

Dual-currency issues

Eurobonds that pay coupon interest in one currency but pay the principal in a different
currency.

Eurocurrency deposit

A short-term fixed rate time deposit denominated in a currency other than the local
currency (i.e. US$ deposited in a London bank).

Eurocurrency market

The money market for borrowing and lending currencies that are held in the form of
deposits in banks located outside the countries of the currencies issued as legal tender.

European Currency Unit (ECU)

An index of foreign exchange consisting of about 10 European currencies,
originally devised in 1979.

Foreign currency

Foreign money.

Foreign currency option

An option that conveys the right to buy or sell a specified amount of foreign
currency at a specified price within a specified time period.

Foreign currency translation

The process of restating foreign currency accounts of subsidiaries into the
reporting currency of the parent company in order to prepare consolidated financial statements.

Hard currency

A freely convertible currency that is not expected to depreciate in value in the foreseeable future.

Index arbitrage

An investment/trading strategy that exploits divergences between actual and theoretical
futures prices.

Multicurrency clause

Such a clause on a Euro loan permits the borrower to switch from one currency to
another currency on a rollover date.

Multicurrency loans

Give the borrower the possibility of drawing a loan in different currencies.

Reporting currency

The currency in which the parent firm prepares its own financial statements; that is, U.S.
dollars for a U.S. company.

Reserve currency

A foreign currency held by a central bank or monetary authority for the purposes of
exchange intervention and the settlement of inter-governmental claims.

Risk arbitrage

Speculation on perceived mispriced securities, usually in connection with merger and
acquisition deals. Mike Donatelli, John Demasi, Frank Cohane, and Scott Lewis are all hardcore arbs. They
had a huge BT/MCI position in the summer of 1997, and came out smelling like roses.

Risk controlled arbitrage

A self-funding, self-hedged series of transactions that generally utilize mortgage
securities as the primary assets.

Riskless arbitrage

The simultaneous purchase and sale of the same asset to yield a profit.

Soft currency

A currency that is expected to drop in value relative to other currencies.

Structured arbitrage transaction

A self-funding, self-hedged series of transactions that usually utilize
mortgage securities as the primary assets.

Triangular arbitrage

Striking offsetting deals among three markets simultaneously to obtain an arbitrage profit.

Virtual currency option

A new option contract introduced by the PHLX in 1994 that is settled in US$ rather
than in the underlying currency. These options are also called 3-Ds (dollar denominated delivery).

Arbitrage

The purchase of securities on one market for immediate resale on
another market in order to profit from a price or currency discrepancy.

Arbitrage

Transactions designed to make a sure profit from inconsistent prices.

Reserve Currency

A currency, frequently the U.S. dollar, that is used by other countries to denominate the assets they hold as international reserves.

American Depositary Receipts (ADRs)

Certificates issued by a U.S. depositary bank, representing foreign
shares held by the bank, usually by a branch or correspondent in the country of issue. One ADR may
represent a portion of a foreign share, one share or a bundle of shares of a foreign corporation. If the ADR's
are "sponsored," the corporation provides financial information and other assistance to the bank and may
subsidize the administration of the ADRs. "Unsponsored" ADRs do not receive such assistance. ADRs carry
the same currency, political and economic risks as the underlying foreign share; the prices of the two, adjusted for the SDR/ordinary ratio, are kept essentially identical by arbitrage. American depositary shares(ADSs) are
a similar form of certification.

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