What is interest rate futures arbitrage? (2024)

What is interest rate futures arbitrage?

Interest rate futures arbitrage is a popular and effective trading strategy that can be used to capitalize on price discrepancies in financial markets. By taking advantage of these discrepancies, traders and investors can minimize their risks while maximizing their profits, and gain an edge in the market.

What is the interest rate arbitrage?

Interest rate arbitrage refers to a method of making a profit by using the difference in interest rates in the two places. An arbitrage is a spread or difference in price between two markets or exchanges for a particular security, currency, or commodity.

How does futures arbitrage work?

In stock-futures arbitrage you buy in the cash market and sell the same stock in the same quantity in the futures market. Since the futures price will expire at the same price as the spot price on the F&O expiry day, the difference becomes the risk-free spread for the arbitrageur.

How does interest rate futures work?

Interest rate futures are contracts that allow buyers and sellers to lock in rates on an interest-bearing asset like a government bond or interbank lending rate. Although actual delivery of these assets doesn't occur, their value is tied to the underlying asset's price.

Is cash future arbitrage profitable?

In the dynamic stock or commodity market, traders always seek strategies that promise profits without significant risk. One such intriguing approach is Cash Future Arbitrage. This strategy helps you earn profit from the discrepancy between a particular asset's present and future prices.

What is an example of interest rate arbitrage?

Covered Interest Arbitrage

For example, suppose that the U.S. dollar (USD) deposit interest rate is 1%, while Australia's (AUD) rate is closer to 3.5%, with a 1.5000 USD/AUD exchange rate. Investing $100,000 USD domestically at 1% for a year would result in a future value of $101,000.

Are there any risks involved in using interest arbitrage?

Interest rate arbitrage, while its immaculate logic, is not without risk. Due to a lack of consistent regulation and tax agreements, the foreign currency markets are risky.

Do people make money from arbitrage?

Arbitrage can be used whenever any stock, commodity, or currency may be purchased in one market at a given price and simultaneously sold in another market at a higher price. The situation creates an opportunity for a risk-free profit for the trader.

Is arbitrage illegal?

Yes, arbitrage is legal in the U.S. Many investors like this type of trading because it provides liquidity and encourages market efficiency by identifying price discrepancies and fostering price convergence.

Can you lose with arbitrage?

In some situations, it is even possible for the investor to have a loss at the con- vergence date of the arbitrage. In this situation, the investor ends up worse off than if he had invested only in the riskless asset.

What is the risk of interest rate futures?

Interest rate futures provide a means for hedging interest rate risk. For example, a borrower might use futures to lock in a fixed interest rate, protecting against future rate increases, which could make borrowing more expensive.

When should you buy or sell interest rate futures?

If interest rates rise, futures prices will fall, so sell futures contracts now (at the relatively high price) and buy later (at the lower price).

What are common interest rate futures?

Common short-term interest rate futures are Eurodollar, Euribor, Euroyen, Short Sterling and Euroswiss, which are calculated on LIBOR at settlement, with the exception of Euribor which is based on Euribor and Euroyen which is based on TIBOR.

What is the formula for future arbitrage?

In such a scenario, the fair price is computed by making use of the formula where F = S*exp(rT) where S stands for the spot price, r is the cost of carry in percentage and T is the time left for expiration in years.

Is it a good idea to arbitrage?

Arbitrage helps in keeping prices of securities across different markets and different market segments more or less in sync with gaps just explained by differential transaction costs.

How long do arbitrage opportunities last?

Arbitrage traders only have to execute trades that last for minutes at most, so the exposure to trading risk is significantly reduced.

What is the most common arbitrage?

Risk arbitrage or Merger Arbitrage is one of the common trades in capital markets. This strategy entails buying stocks that are in the process of a merger or acquisition or amalgamation.

Where is interest rate arbitrage possible?

Covered interest arbitrage is only possible if the cost of hedging the exchange risk is less than the additional return generated by investing in a higher-yielding currency—hence, the word arbitrage.

Which is the best example of an arbitrage?

For example, one painter's paintings might sell cheaply in one country but in another culture, where their painting style is more appreciated, sell for substantially more. An art dealer could arbitrage by buying the paintings where they are cheaper and selling them in the country where they bring a higher price.

What are the disadvantages of arbitrage?

One of the primary disadvantages of arbitrage funds is their mediocre reliability. As noted above, arbitrage funds are not very profitable during stable markets. If there are not enough profitable arbitrage trades available, the fund may essentially become a bond fund, albeit temporarily.

Why is arbitrage difficult?

Finding a pure arbitrage opportunity is difficult, as advancements in pricing technology have made the discrepancies between exchanges disappear as quickly as they come. Today, a lot of arbitrage opportunities are found by algorithms – complex programmes that identify price differences and execute trades automatically.

Can you lose money in arbitrage trading?

It's possible to lose money due to slippage, trading fees, and unforeseen shocks in crypto price movements. Some of the risks to consider include: Price Slippage: This is one of the most important considerations in arbitrage trading, particularly in fast-moving markets with high volatility.

Why is arbitrage trading illegal?

Arbitrage trades are not illegal, but they are risky. Arbitrage is the act of taking advantage of a discrepancy between two almost identical financial instruments. These are typically traded on different financial markets or exchanges. It happens by buying and selling for a higher price somewhere else simultaneously.

How much does it cost to start arbitrage?

Pros of rental arbitrage

One of the biggest plus points for rental arbitrage is the low start-up costs. As we said before, you can get started in rental arbitrage with just $5,000. It's a pretty safe bet that you can find an apartment to rent for $2,000 per month. To this, add in a 50% rent deposit of $1,000.

Do banks do arbitrage?

Outward arbitrage occurs when interest rates are lower in the United States than abroad, so banks borrow in the United States at a low rate, then lend abroad at a higher rate, profiting from the difference. Inward arbitrage is the opposite, and occurs when domestic rates are higher than those abroad.

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