Arbitrage?

Question

Is arbitrage simply the process of buying and selling securities? or am I totally off.

Answer 1

I am an economist and professional investor and no one has correctly answered your question.

Arbitrage is the riskless purchase of one asset and simultaneous sale of another in such a way that you have no money invested and you are guaranteed a profit without risk.

The classic example if company A is buying company B, one share for one share. Company A's stock is selling for $50 per share and company B's stock is selling for $48. You sell short, Company A's stock for whatever you can borrow and simultaneously buy Company B's stock. You sell stock you do not own at $50 and use the money to buy the other stock at $48. You pocket the $2. When the company sends you the shares of company A in place of the shares of company B, you then pay back the short seller. You keep the $2. There is a mutual fund that actually does only this.

Another example, but one that should be riskless, but isn't is Unilever. Unilever PLC and Unilever NV each own precisely half of the Unilever Group. Each one is half the company, it is really just two perfectly identical classes of shares with identical rights trading under two different tickers. They often trade far apart in price. You should be able to short one and buy the other, but this can go on for years and has been as much as a 35% difference before the prices converged. If you bought at a 10% difference you would lose 20% of your money before the market caught on, a few years later, of how big an error this was.

For it to be arbitrage, you must have no money of your own invested, there must be no risk at all, and you must make a profit. It is the proverbial free lunch. It can be done, it is hard to find the opportunities unless you spend a lot of time looking.

Answer 2

You're dead on...sorta. :)
Its not just buying and selling, but doing so in rapid succession. For example, you sell 100 shares of xyz stock and immediately buy 100 shares of ABC stock, before the first transaction was completed and payment made (as it takes 3 days to fully complete both transactions). Doing it this way closes one position while opening another, which is completed and finalized on the same day.
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Mr. Economist has incorrectly answered the question. Figures. This is not a risk-free process!!
You are selling a position and with the funds purchasing another. YOU DO NOT HAVE THE FUNDS YET!!!
Thats the what makes it an arbitrage. There is ALWAYS the possibility that you will not get the funds from your sale on time, BUT YOU MUST pay for the purchased position...which means if you don't have the money you are in an hurtlocker.
I deal with this on a constant basis, and while I recommend people don't do it, simply because it borders on impulsive, there are always a few who want to and a few situations where it is certainly warranted.

Answer 3

Arbitrage is done with two investments.

One side you have a simple securities like a stock or a bond. Second side is a replicating portfolio. You must look at a bond and see if it moves with any other bonds. However, if the bonds are extremely similar yet aren't trading proportionately, you can buy the same face value of each.

Example:

Sell (Short) Bond A @ $750.

Buy (Long) Bond B @ $249.97. (Actual value $250.)
Buy (Long) Bond C @ $249.92. (Actual value $250.)
Buy (Long) Bond D @ $249.95. (Actual value $250.)

These transactions must happen exactly at the same time and the the four bonds must have extremely similar movements.

When market forces bring the bonds to the right price, sell the portfolio for $750 and buy back your shorted bond @ $750. You will have made $0.16 on the transaction. However, banks do this in millions generating much larger gains.

This is a VERY GENERAL explanation. There is far more complex computations required in finance (done in my Fixed Income Securities Course).

Hope this somewhat explains it.

Answer 4

Arbitrage is "Financial transaction involving the simultaneous purchase in one market and sale in a different market with a profitable price or yield differential. True arbitrage positions are completely hedged--that is, the performance of both sides of the transaction is guaranteed at the time the position is assumed--and are thus without risk of loss. A person who engages in arbitrage is called an arbitrageur or arb."
That's the best I can do since I am not currently participating in the investment markets (Stock market, bond market, etc.).

Answer 5

Arbitrage is a way of trading which uses difference in odds in several bookmakers, and guarantee you profit with 100% RISK FREE. From my arbets you can enjoy this service
Arbitrage

Answer 6

Basically its buying 1 and shorting another similar type security. Like GS and LEH are very similar and move in similar ways. So if lets say that GS went down 5 dollars and LEH went up 5 dollars, you would want to short LEH and go long GS and cover when they go back in sync....Its a little more complicated than that,(like you also have to figure out how much shares to buy of one and how much to short of the other because they have different stock prices.) Its also a little hard to do unless you have direct access because miliseconds can count in that game.

Answer 7

Arbitrage is making money off of exchange rates

Answer 8

for example: buy us dollars for low price in one market then resell to another market immediately for more (higher ex-rate val.). these op's are rare and shortlived. gl.


cheers!

Answer 9

Its more taking advantage of them.

Answer 10

sweet