Super Fitness Health BlogThe Concept of Financial Arbitrage Discussed
In business economics, investment and sports, arbitrage is the concept of taking advantage of a price difference between 2 or more markets: striking a combination of matching deals that take advantage upon the imbalances, the gain being the gap amongst the market prices.
When employed by academics, an arbitrage can be a transaction that concerns no bad cash flow at any probabilistic or temporal state and also a positive income in one or more state; in simple terms, it is the possibility of a risk-free profit at zero cost.
In principle and within academic use, an arbitrage is risk-free; in common use, such as statistical arbitrage, it could reference expected profit, though losses may happen, and in practice, there are always risks in arbitrage, some minor (such as change of prices decreasing income), some major (including devaluation of a currency or derivative).
In academic use, an arbitrage involves benefiting from variations in price of a single asset or identical cash-flows; in common use, it might be used to reference differences between similar assets (relative value or convergence trades), such as merger arbitrage.
Those who engage in arbitrage are called arbitrageurs perhaps a bank or brokerage firm. The phrase is principally applied to trading in financial instruments, which include bonds, stocks, derivatives, products and currencies.
Specific sport arbitrage has also recently become feasible because of the availability of online bookmakers giving widely diverging odds on sports producing situations where you’re able to place bets that cannot lose.
Even though this involves bookmakers it is far from gambling as there isn’t any risk to the initial stake which cannot be lost. This is known as ‘Arbitrage Betting‘ or ‘Matched Betting‘
Arbitrage is not simply the act of buying a physical product within a market and selling it in another for a higher price at some later time. The deals must take place simultaneously to avoid exposure to market risk, or perhaps the risk that prices may change on a single market before both dealings are finished.
In practical terms, this is generally only possible with securities and financial products that may be traded electronically, and even then, when each leg of your trade is performed the prices in the market may have moved.
Missing one of the legs from the trade (and subsequently having to trade it soon after at a worse price) is called ‘execution risk’ or more specifically ‘leg risk’.
“True” arbitrage requires that there be no market risk included.
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