Arbitrage Profits

[myfavname]

This was a question in an old examination and my friends and me argued about the answer for a long time, but did not come to a reasonable conclusion:

Explain how traders exploiting foreign exchange arbitrage opportunities bring the foreign exchange markets around the world into equilibrium.

We do not understand why there can be an equilibrium anyway, because traders would just sell expecting a profit, so there would not be any losses equalizing the profits...

 

[ogarbitrage]

Quote from myfavname:

Explain how traders exploiting foreign exchange arbitrage opportunities bring the foreign exchange markets around the world into equilibrium.

We do not understand why there can be an equilibrium anyway, because traders would just sell expecting a profit, so there would not be any losses equalizing the profits...

Pretty easily.

Equilibrium is par value between a synthetic pair and its live equivalent. If the synthetic is premium, it is sold while the discounted live pair is bought, and vice versa.

Thus removing the disparity and bringing them back into equilibrium.