What the hell is Arbitrage??
The practice of making money by taking advantage of the imbalance between two or more markets is known as arbitrage. Dictionary.com defines it as :
for example - A share X is trading on NSE at a price of 65.17 Rs while at the same time it is trading at 65.21 Rs on the BSE so if someone buys 100 shares on NSE and sell it on BSE at the same time he will make Rs4 without any investment this practice is known as arbitrage and those who practice this are known as arbitrageures .
Arbitrage can be practiced when any one of the following three principles is not met :
In this age of short term transaction tax arbitrage may not seem an attractive option but buying in national commodity exchange and selling in international markets do provide operating margins enough to make huge profits with well absolutely no investment at all.
The purchase of securities on one market for immediate resale on another market in order to profit from a price discrepancy.
for example - A share X is trading on NSE at a price of 65.17 Rs while at the same time it is trading at 65.21 Rs on the BSE so if someone buys 100 shares on NSE and sell it on BSE at the same time he will make Rs4 without any investment this practice is known as arbitrage and those who practice this are known as arbitrageures .
Arbitrage can be practiced when any one of the following three principles is not met :
- Same commodity must have same price in all markets.
- Two commodity with identical cash flow must trade at same price
- An asset with a known price in the future, must today trade at its future price discounted at the risk free rate.
In this age of short term transaction tax arbitrage may not seem an attractive option but buying in national commodity exchange and selling in international markets do provide operating margins enough to make huge profits with well absolutely no investment at all.
posted by Shrey at 2:26 PM
2 Comments:
Well, this is the first time I am writing something on this blog.
Speaking of arbitrage, I really dont understand how can one earn profit from this in India in equity market as
1. In India market fluctuations is too high as compared to Dow Jones or any big american market. So there is a very high risk involved in purchasing shares from BSE, for example and selling at that very time in NSE as in a split of a second market price will change and you may soon end up loosing some money.
2.whatever little margin was there in arbitrage ended after transection tax was imposed.
So, the question comes where does arbitrage helps us. As I percieve, the only place where this is useful is commodity market. The point is how does the difference in prices come. This difference in price is due to two levels of market having some commodity in common for trading. For eg. gold operates in international market as well as national commodity market. Now, the difference comes in future prices of the two markets as future price is lower in intermational market than natioanl commodity markets in developing countries like India because rate of interest in very low in developed countries than in developing countries. Difference in prices can also be observed in grains as grains are operated in commodity market as well as local markets known as "mandis".
The profit in arbitrage is at zero risk but then where is the catch. One of the difficulties in operating in commodity market is that you need huge amount of cash money to make profit in it as one has to pay for the purchase of commodity in present while he would get the return when the transaction is done in future . Like for example one need about 10 lack of money to puchase gold from banks while he would get the profit of about 15 thousand rupees when his future transaction is done. So, the person having huge amount of black money can only make profit in this market.
Why were mutual funds needed to cash in on arbitrage in equity market??
Well as ashish pointed out the return you get from arbitrage is very low. The process is simple buy a share in one market and sell it in the other market. The difference in price in the two market(which is very low most of the time) is your profit per share. So to earn large amount of profit you need the funds to buy stocks in wholesale. People invest in the mutual funds expecting higher return(though there is some risk involved) and the money invested by the public is used by the fund operators to buy large amount of stocks to earn money through arbitrage.
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