For a currency arbitrage situation,
Lets suppose the futures contract on the EURO (quoted as GBP/EUR) is trading above its fair value then what arbitrage transactions should be conducted?
According to the Curriculum, buy Euros and sell euros futures contract. My issue is that if the contract GBP/EUR is trading above its fair value then that means that Euros are overvalued and we should sell the EUROs.
Anyone?
futures contract is overvalued based on current price… (that doesn’t mean euros are not fairly priced right now)
therefore you sell futures contract and buy euros now…
Here is how I understood it: The futures contract on the EURO is overvalued (quoted as GBP/EUR) so if the fair value is 1.9 GBP/EUR then the contract is set at 2 GBP/EURO. In this case if we sell the contract that means we would be offering someone this rate to someone else-so they could buy more GBPs per Euro than what is fair-How is that profitable?
I think My main misunderstanding comes from “The futures contract on the EURO is overvalued (quoted as GBP/EUR)” where I dont understand if the nominal rate is higher or lower than fair.
If the GBP/EUR quote is higher than its fair value (too many GBP per EUR), then we want to receive the too many GBP at the end. Start by borrowing GBP and selling them in the spot market (buying EUR in the spot market), and buying them in the forward market (selling EUR in the forward market).