What is Arbitrage?

February 28, 2014

Finance

What is Arbitrage?The practice of arbitrage is that of trading price discrepancies in the stock market. It is a financial venture involving the purchase of stocks on one market at a low price and a quick turnaround at selling the same stock for a higher price on a different market. A successful arbitrageur is able to follow trends and look for opportunities which present as price differences wherein a profit may be gained.

As the profit margin fluctuates within the market, there is a window of opportunity which must be acted upon quickly as the imbalance could turn into a profit loss rather than a profit. Many arbitrageurs follow this strategy with the knowledge that time is of the essence in order to be successful. Overall, such investments are risk free in turning a profit and an experienced investor has a good eye for finding such price differences.

Arbitrage is when an imbalance of pricing occurs of the same goods on the market. It can be explained as a time fluctuation on a global scale. As prices change and are updated systematically, there are system occurrences which cause delays in information processing of data. These delays result in the data being out of sync for a moment in time which creates an informational lag.

These delays can be quite profitable for experienced arbitrageurs, whose main function is to look for these particular conditions with a readiness to act upon them. There are certain conditions which equate possibilities to be aware of and only one has to be present to turn a timely profit. The main course of action is simply reliant on recognition of a price for a good that differs from one market to the next.

Arbitrage takes place upon buying shares of that good at the lower priced market and turning around and selling it on the higher priced market. The transaction must be instantaneous from one to the other, and if conducted in a timely manner will yield a risk free profit. Exposure to market risk is always present. This poses the threat of an untimely arbitrage action in which the prices become synced on the various markets prior to the transaction being completed.

The practice of arbitrage does have a compliant policy. It involves interest earning bonds and IRS reporting methods. Complex calculations performed advise of being in receipt of an arbitrage rebate versus that of making a yield reduction payment. A yield restriction calculations will advise if one has gone under (rebate) or over (payment)the amount of arbitrage investments allowed per compliant restrictions on profits earned. The yield restriction calculations will also show if amounts earned require to be reported to the IRS for tax purposes.

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