Question

Explain the causes of arbitrage between forward market hedge and money market hedge.

Answer 1

Forward Market :

Forward is a derivative contract where all terms and conditions about the rate, date, place , quantity etc are derived at the time of entering into a contract, however, actual implementation is done on a later date.

Arbitrage : a process of earning profits without taking any risk as such

Forward Market Hedge : means purchasing of a currency at a forward foreign exchange rate anticipating the upcoming rise or fall.

Money Market Hedge : is primarily used to offset the effect of fluctuations in the exchange rate, the domestic country locks the exchange rate based on the current rate and does not have to pay for the fuctuations.

The cause of arbitrage in this process would be if one knows the quoted 1 year US-dollar interest rate and sees the opportunity to take position in the market