This document discusses arbitrage, nominal effective exchange rates (NEER), and real effective exchange rates (REER). It provides the following key points: 1) Arbitrage involves buying the same asset in different markets simultaneously to profit from price discrepancies. Triangular arbitrage exploits exchange rate discrepancies across currency pairs. 2) NEER is a weighted average exchange rate that indicates a country's international competitiveness. It incorporates exchange rates against a basket of currencies weighted by trade volumes. 3) REER adjusts the NEER for inflation differences between countries to reflect exchange rate changes in real terms. When exchange rates are fixed, there is no difference between NEER and REER since other economic factors

1. Arbitrage
&
Effective Exchange Rate
DR RAJU INDUKOORI
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2. Arbitrage
• The price differentials of an underlying
currency with different foreign
exchange opens an opportunity to
profit.
• It is the process of buying the same
asset in different markets
simultaneously.
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3. Triangular Arbitrage
• Exchange rate discrepancy provides
an opportunity to buy currency pairs
simultaneously.
• It is a quick process as price
discrepancies will be identified by all
traders in forex market.
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4. Triangular Arbitrage
Example
Exchange rates
• INR / USD @ 80
• INR / AED @ 20
• AED / USD @ 4
If there is any change in one of the
exchange rate, rest of the exchange rates
will change automatically.
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5. Triangular Arbitrage
Example
• If INR / AED changes to 18, then
INR / USD also changes.
• Till the time it changes, there is
always an opportunity for
triangular arbitrage.
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6. Triangular Arbitrage
Example 6

7. NEER
 Nominal Effective Exchange Rate
 It is weighted average rate at which one
country's currency exchanges for a basket of
multiple foreign currencies.
 It is an indicator of a country's international
competitiveness in terms of the foreign
exchange market.
 Forex traders sometimes refer to the NEER as
the trade-weighted currency index.
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8. NEER Calculation
Where
E = Exchange Rate
t = Value of trade with first country
T = Total trade value of a country with all countries
N= Number of trading countries
T
t
E
T
t
E
T
t
E
T
t
E n
n
.......
NEER 1
1
1
1
1
1 


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9. REER
 Real Effective Exchange rate
 NEER is adjusted to the exchange inflation in the
respective countries.
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10. REER Calculation
Where
E = Exchange Rate
t = Value of trade with first country
T = Total trade value of a country with all countries
N= Number of trading countries
i = Inflation in the respective country
        T
t
i
E
T
t
i
E
T
t
i
E
T
t
i
E n
n
n







































1
.......
1
1
1
REER 3
3
3
2
2
2
1
1
1
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11. NEER and REER
 When the exchange rate is pegged or
fixed, there is no difference between
NEER and REER as exchange rate is
not determined by interest, inflation,
country risk kind of factors.
 Ex : AED / USD is fixed at 3.67
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