Define arbitrage in the context of foreign exchange.

Arbitrage in the context of foreign exchange refers to the simultaneous purchase and sale of a currency in different markets or in different forms to capitalize on price discrepancies. Traders engage in arbitrage to take advantage of the variations in currency values across different exchanges or trading platforms. When a currency is priced lower in one market compared to another, a trader can buy the currency at the lower price and immediately sell it at a higher price elsewhere, thereby securing a profit without taking on significant risk.

This practice is essential in maintaining market efficiency, as it helps to align currency prices across various markets. It allows traders to exploit inefficiencies and helps ensure that prices reflect accurate demand and supply dynamics. The nature of arbitrage means that it is usually executed very rapidly, as price differences tend to correct themselves quickly due to the actions of arbitrageurs.