Arbitrage a Fundamental concept of Finance
Arbitrage a Fundamental concept of Finance
Arbitrage is one the fundamental financial concepts. It can be defined as obtaining profit from the price difference by purchasing and selling an asset simultaneously. For example, if you are buying an asset at a lower price say $150 and you are selling the same asset immediately in a different market at higher price say $200, then you will gain $50 out of it. This is called an arbitrage profit. It can also be called as risk free profit. A person who involves in arbitrage is called arbitrageur. Here are some ways in which arbitrage profit can occur.
First type of arbitrage: This type of arbitrage occurs when a good is available in one market at a lower cost and there is a demand for the same good in another market at higher cost. This type of arbitrage is very common in eBay. For this, you should know the list of rare goods and their availability. To find those goods, you have to spend a considerable time and energy. But it is highly impossible to make a profit like this for a long time.
Second type of arbitrage: This kind of arbitrage arises, if the transaction involves two or more currencies. There will always be an exchange rate between two currencies. There may be some difference in these exchange rates at times. Making profit out of such differences is also a form of arbitrage which is of second type.
Third type of arbitrage: This type of arbitrage usually arises in stock markets and convertible bonds. It is also known as relative value arbitrage. This type of arbitrage is quite complicated but the underlying logic is same everywhere.
Arbitrage profits are mostly short lived. The opportunities for arbitrage are hard to come due to transaction costs and more people are looking for the same.
