Assume you discovered an opportunity for locational arbitrage involving two banks and have taken advantage of it. Because of your and other arbitrageurs' actions, which of the following adjustments must take place?

Question

Quizplus · Accepted Answer

When arbitrageurs take advantage of a locational arbitrage opportunity, they buy the currency at a lower price in one bank and sell it at a higher price in the other bank. As a result, the demand for the currency increases in the lower-priced bank, causing their ask price to rise. Conversely, the supply of the currency increases in the higher-priced bank, causing their bid price to fall. This results in one bank's ask price rising and the other bank's bid price falling.

Moreover, as arbitrageurs buy and sell the currency between the banks, the bid/ask spread in the lower-priced bank will become narrower due to increased demand, while the bid/ask spread in the higher-priced bank will widen as arbitrageurs try to sell their currency. Therefore, one bank's bid/ask spread will widen, and the other bank's bid/ask spread will fall.

Assume You Discovered an Opportunity for Locational Arbitrage Involving Two