Saturday, November 15, 2008

Arbitrage


Arbitrage is something that was introduced to me by a friend in the business faculty this year. I found the idea very intriguing as it provides an opportunity to get a risk free profit.

The idea behind this is to make use of market inefficiencies, and is usually applied in financial instruments such as bonds, stocks, derivatives, commodities , currencies etc.


A simple example would be:

Exchange rate in London are £5 = USD10 = ¥1000
and the exchange rates in Tokyo are ¥1000 = USD12 = £6

So with £5 in London, you change to ¥1000 and using this ¥1000, you go to Tokyo and change it back to £6. An instant profit of £1 !


This is 'triangle arbitrage'. Though this example is so simple that it does not occur, but it serves as in illustration of market inefficiencies where you can take the chance to make a risk free profit.


I shall give a few more actual examples that are happening in my future posts. It is good to know about this, because it is really a simple way to make a quick risk free profit. The most difficult part I feel, is to actually find such opportunities, as they are usual rare and do not last long.

Wikipedia link : http://en.wikipedia.org/wiki/Arbitrage

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