Arbitrage refers to the process by which investors sell and purchase different currencies in more than a market. Investors consider arbitrage to make more profits from the differential in the market exchange rate in different markets. Differential market exchange rate occurs due to inefficiencies in markets. In most cases, investors make more profits by exploiting price differences of similar financial instruments in diverse markets. In foreign exchange investments, arbitrage helps investors to capitalize on price differences for the same asset over a given period. Seasonal price differences of assets between two or more markets enable investors to lock in profits ( Brijs et al., 2019) . Investors usually try to exploit the arbitrage opportunity by purchasing more stock on the foreign exchange where share prices have not been adjusted due to fluctuating exchange rates.
On November 22, 2020, Honda Motor Company's stock closed at ¥ 2,977 on the Tokyo Security Stock Exchange. Currently, Honda stock trades as an ADR on the NYSE ( ADR.com, 2020) . One share of Honda equals one ADR. On November 22, 2020, the ¥/$ sports exchange rate is ¥103.86/$ 1. The currency exchange rate of ¥ to the U.S. dollar has significantly increased over the past five years. The progressive fluctuation of ¥ to the U.S exchange rate is caused by the weakening of the Japanese yen against the United States dollars ( ADR.com, 2020) . The current exchange rate of ¥ to the U.S is beneficial to foreign investors who would wish to invest in foreign stock.
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ADR (Dollar Price) = Value per Share in ¥
Exchange rate
ADR (Dollar Price) = ¥ 2,977/ 103.86
ADR (Dollar Price) = 28.66
An American depositary receipt (ADR) is defined as a negotiable certificate issued by the United States depository bank expressive a certain number of shares. ADRs enable United States investors to purchase stocks that are not available in local countries. Foreign firms are also benefiting from investing in a stock that arises due to fluctuation in exchange rates. Since the Dollar Value of each ADR is $ 28.66, there is no arbitrage opportunity in this case. There is no arbitrage opportunity because the transaction cost is deducted, which is closely equal to the trading market price ( ADR.com, 2020) . Arbitrage opportunities exist when investors can invest nothing, or less amounts yet will still expect positive payoff or returns in the future. When comparing the Honda ADR to the price of shares of Honda stock placed in Yen, arbitrage opportunities exist because investors will still expect more returns or profits in the future. When expecting arbitrage opportunities, it is prudent to break transactions into the mix because when the cost is excessively high, they may neutralize investors' expected profits.
In the bottom line where the markets are perfectively efficient, and the foreign exchange does not exist, the arbitrage opportunities cease to exist. However, when the market is seldom perfect, it will give investors arbitrage opportunities to capitalize on pricing inconsistencies. Under such a scenario, investors should invest in shares when the market is seldom perfect because it will allow them to earn profits for investing in shares. In some instances, retail traders have opportunities to engage in risk arbitrage ( Brijs et al., 2019) . Risk arbitrage is different from pure arbitrage because it involves various risks, while pure arbitrage focuses on locking traders' profit.
In summary, arbitrage is a process that helps investors to purchase foreign shares at low prices and sell them when the prices are high. However, the foreign currency's currency exchange rates play an integral role in determining the amount of profits earned by investors on a certain investment. Therefore, investors must consider the foreign exchange rate before investing in foreign stock.
References
ADR.com. (2020, November 20). J.P. Morgan's adr.com . J.P. Morgan's adr.com | The premier site for the global investor. https://www.adr.com/drprofile/438128308
Brijs, T., Geth, F., De Jonghe, C., & Belmans, R. (2019). Quantifying electricity storage arbitrage opportunities in short-term electricity markets in the CWE region. Journal of Energy Storage , 25 , 100899.
