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The concept of Arbitrage

Arbitrage is the process of making profit from the price difference between two or more markets and a person who engages in arbitrage is called an arbitrageur. For example, an investor is trading simultaneously in NSE and BSE, for particular stock the price in BSE is lower than the trading price in NSE. He can then make profit from this price difference by opting for arbitrage. But arbitrage is not the simple act of buying one asset at one market and then selling it to another market at a later time when the price is higher. Rather to avoid market risks of price change you need to make sure that both the transactions at both the market are done simultaneously. To eliminate the risk of price fluctuation you need to make sure that both the transaction is completed even before the change in the price at any of the markets.

Arbitrage is typically associated with trading in financial instruments like bonds, stocks, derivatives, commodities and currencies. There are different types of arbitrage including Merger arbitrage, Convertible bond arbitrage, Regulatory arbitrage, Depository receipts, Municipal bond arbitrage, and Telecom arbitrage. There are some preconditions that are essential for a profitable arbitrage to take place. If any one of the following point is true for a given condition then it is assumed that a profitable arbitrage is possible,

  • The same asset does   trade at the same price at different markets.
  • Two assets do not trade with the similar cash flow at the same market.
  • An asset with a known price of the future does not trade on a given day at the market that is discounted at the risk free interest rate.

If you want to maximize your profit from arbitrage you need to make sure that the asset you trade in are electronically traded across different markets. Only then you can effectively make the transactions at the real time and maximize your profit from the whole process. Arbitrage when done in an informative way and with proper stock market analysis can effectively increase your profit limit. To ensure that you get maximum return from the arbitrage consult your stock broker or financial advisor for the proper asset and for the best time.

Posted by On 22/01/2010 Filed in: General Tags: , , ,
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