3. Arbitrage and spot exchange rates

Suppose you trade dollars and euros for a bank that has branches in Los Angeles and Frankfurt. You can electronically transfer the funds between the two branch locations at no cost, and trading commissions are negligible. The current dollar-per-euro exchange rate in Los Angeles is E$/EURLA=1.5818E$/EURLA=1.5818, while in Frankfurt, it is E$/EURFR=1.5503E$/EURFR=1.5503.

You can make a profit for the bank if you buy euros in (Frankfurt or Los Angeles ) and sell them in (Frankfurt or Los Angeles ).

Assuming other foreign exchange traders face the same exchange rates you do, they will buy dollars in (Frankfurt or Los Angeles ) and sell them in (Frankfurt or Los Angeles ). As a result, the dollar-per-euro exchange rate in Frankfurt (E$/EURFRE$/EURFR) will (rise/fall) , and the dollar-per-euro exchange rate in Los Angeles (E$/EURLAE$/EURLA) will. (rise/fall) .