Lesson 2 of 6 · All lessons in this module
- Building a cross-rate from two quotesVideo lesson
- Triangular arbitrage and reading currency moves
- Forward points, premiums and discounts
- The no-arbitrage link between spot, forward and interest ratesVideo lesson
- Forward points, maturity and the rate differential
- Integrated cases: hedging a receivable and comparing dealers
Lesson 2 of 6 · 13 min
Triangular arbitrage and reading currency moves
A quoted cross-rate must match the rate implied by the two underlying quotes, or traders earn a riskless profit by trading around the triangle; and a change in a quote tells you which currency strengthened and by how much.
In short
- If a dealer's cross-rate differs from the implied cross-rate, buy the currency where it is cheap and sell it where it is dear: triangular arbitrage, so called because three currencies are involved.
- Profit per unit of base currency = the gap between the two rates, paid in the price currency.
- Such gaps are rare and tiny because traders and algorithms remove them almost at once; in calculations we assume cross-rates are consistent.
- A rise in a price/base quote means the base currency appreciated; its percentage change is new ÷ old − 1.
- For the price currency, invert first: its change is old ÷ new − 1, which is not simply the negative of the base currency's change.
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