Can Arbitrage Exist In Stock Market Example For Free - Free Essay Example

Sample details Pages: 7 Words: 2062 Downloads: 7 Date added: 2017/06/26 Category Finance Essay Type Narrative essay Did you like this example? Arbitrage basically refers to the practice of taking advantages of the difference between the prices in two different markets. The advantage is the profit being the difference between the market prices. Arbitrage is an activity of purchasing or buying in one market and simultaneously selling them in another different market. In the other meanings, it means that arbitrage attempts the profit by exploiting the price differences of identical or similar financial instruments, on different markets or in different forms. An arbitrage also refers to a transaction which involved no negative cash flows at any temporal or probabilistic state and a positive cash flow in at least one state. It is the possibility of a risk free profit or risk-free gain at zero cost. Arbitrage traders are known as arbitrageurs and the term arbitrage are primarily implemented in the buying and selling of financial instruments, for example stocks, bonds, derivatives, commodities, as well as curre ncies or foreign exchange. The condition is known as an arbitrage-free market or arbitrage equilibrium if there is a condition that no profit could be made out from arbitrage transactions. All the prices existing in that market are responsible for forming such a condition. An arbitrage equilibrium or arbitrage-free market functions as a prerequisite for a general economic equilibrium. This process only takes place under few conditions. Firstly, an arbitrage takes place when the same financial instrument is not traded at equal prices in every market and this condition is known as the law of one price. Secondly, it happens when two financial instruments that have similar cash flows but not traded at the same prices in the market. Lastly, an arbitrage will takes place when a commodity, which has a fixed price in the future, is not traded at the present time at a risk free interest rate and future discounted price. Arbitrage can be categorized into three groups in the real world w hich are pure arbitrage, near arbitrage and also speculative arbitrage. Pure arbitrage is the arbitrage where someone risks nothing and earns more than the riskless rate. For the near arbitrage, it is where someone has assets that have identical or almost identical cash flows, trading at different prices but there is no guarantee that the prices will converge and there exist significant constraints on the investors forcing convergence. Speculative arbitrage is an arbitrage which it may not really be arbitrage in the first place and at here, the arbitrageurs take advantage of what they see as mispriced and similar assets, they will buy the cheaper one and selling it with expensive in different markets. There are many different types of arbitrage appear in the markets such as municipal bond arbitrage, merger arbitrage, depository receipts, convertible bond arbitrage, statistical arbitrage, covered interest arbitrage, uncovered interest arbitrage, triangle arbitrage, telecom arbitra ge, political arbitrage, regulatory arbitrage, fixed income arbitrage and volatility arbitrage. Municipal bond arbitrage is one type of the arbitrage which is also known as municipal arbitrage or municipal bond relative value arbitrage. This is basically a hedge fund strategy. In case of municipal bond arbitrage, the hedge fund managers apply two approaches. The first approach is seeking the relative value benefits both in case of short-term municipal bonds and long-term municipal bonds through a duration-neutral look. The second approach refers to the interest rate swaps between the municipal bonds. Another type of arbitrage is merger arbitrage, which is also known as risk arbitrage. In this type of arbitrage, it usually includes buying the target companys stock. Generally, the market of the target company is below the price proffered by the acquiring company. The swell between these two prices depends primarily upon the probability and the timing of the takeover being accomp lished in addition to the prevailing level of interest rates. The stock of a particular company which is going to be taken over is purchased and at the same the time, the stock of the company which is going to take over the former company are short sold. A depository receipts is a form of a security which is provided in the form of a tracking stock on a financial market located in another country. At here, the profit is arises from the spread between the real value and the perceived value. For statistical arbitrage, it refers to a discrepancy in the expected nominal value. In this kind of arbitrage, the arbitrageurs will take the advantages of the differences in anticipated values. Volatility arbitrage is a form of statistical arbitrage. It is used with the help of buying and selling of a delta neutral option portfolio and the underlies of the portfolio. Besides that, another type of arbitrage is convertible bond arbitrage. A convertible bond is a type of bond which can be con verted into a specified number of shares of a company or considered as a corporate bond with a stock call option attached to it. Convertible bond prices are dependent on three elements which are the credit spread, the stock price and the interest rate. The profit of a convertible bond arbitrage arises from the functions of these elements. For example the stock price, when the price of the stock is convertible to moves higher, the price of the bond tends to rise. Covered interest arbitrage is a financial instrument or security bought by an investor in the domination of a foreign exchange or foreign currency and the foreign risk hedged through the sale of a forward contract in the sales proceeds of the financial instrument again in the domestic currency. The investor is able to know the exact proceeds of the transaction only if the investment is risk-free in nature and interest is received by the investor only once. The interest is paid to the investor on a particular day when the forward contract sale in foreign exchanges takes place. Alternatively, there is a certain degree of foreign currency risk involved. For uncovered interest arbitrage, it is a type of arbitrage where there is a transfer of funds to overseas locations taking the benefit of enhanced interest rates in foreign exchange bureaus or foreign exchange agencies. In this type of investments, the domestic currency is changed over to a foreign exchange and again at the maturity period, the proceeds from the foreign exchange are reconverted to the base or domestic currency. There is an involvement of foreign currency risk because of the probable decrease in the value of the foreign exchange in the duration of investment period. Both forms of interest arbitrage, covered interest arbitrage and uncovered interest arbitrage have become quite popular in various sector of the financial market. For regulatory arbitrage, this arbitrage is the one that includes a regulated institution or organization to take the advantage or benefit of the difference between the regulatory position and the economic or the real risk. Another type of arbitrage is triangle arbitrage. This arbitrage is also known as triangular arbitrage and in this approach, the benefits or the advantages are taken out from a condition of disequilibrium lying between three foreign markets. For the telecom arbitrage, this type of arbitrage strategy is utilized by the Telecom arbitrage organizations, such as Action Telecom UK. However, there is also a political arbitrage. In this kind of arbitrage, political knowledge or calculations about the future are implemented for discounting and forecasting values of securities. The major factor in the values of some foreign government bonds is the risk of default, which is political decision taken by the countrys government. Fixed income arbitrage is another one important form of arbitrage. In this type of arbitrage, the investment strategies are usually or primarily related t o the hedge funds. The investment strategy involved in fixed income arbitrage comprises of finding and capitalization of the defects in bond pricing. The processes of fixed income arbitrage are applied in the case of financial instruments which issued by both private sector issuers and public sector issuers and it carried a fixed and contractual flow of incomes. Majority numbers of the arbitrageurs who are involved in this fixed income arbitrage strategy carry out their trading operations on a global basis. For the purpose of accomplishing both of the objectives of minimum unpredictability and stable return, the arbitrageurs often concentrates on the United States non-US government bond arbitrage, where the interest rate are swaps, the United States treasury securities, mortgage-backed securities (MBS), as well as the forward yield curves. Fixed income arbitrage is also a type of an investment strategy, which tries to gain from the chances of arbitrage from the securities which c arrying the interest rates. At the time of utilizing the strategy of fixed income arbitrage, the investors may presumes counterbalancing positioning in the market in order to avail the benefit of minor price deviations and at the same time, restricting the interest rates risk. The strategy of this fixed income arbitrage is principally implemented by the reputed investments banks and the hedge fund institutions all over the world. The most basic type of income arbitrage is the swap-spread arbitrage. This has comprises the holding counterbalancing short and long positions in case of treasury bonds and swaps. These types of strategies have offered the comparatively lower degree of return and also some of the instances, substantially large amount of losses. Generally, the application of this kind of arbitrage is equated or likened with running ahead of a steamroller for picking up nickels existing on the path. This is because of the risk factor which involved in fixed income arbitrage. As a conclusion, there are many different types of arbitrage appear in the different market. Each type of the arbitrage has its own characteristics. Arbitrage is a way to make almost guaranteed profit but there is also a risk due to this arbitrage. For example, in order to take advantage of price differentials and information disparity between traders or arbitrageurs within the market, the traders must usually be completed within a short space of one another. Otherwise, the market will, theoretically, account for the uneven pricing and correct by itself. For this reason, many arbitrageurs on betting exchanges use software designed to find and exploit price differences between traders faster than possible manually. Another risk of arbitrage is a lack of liquidity in the market. Liquidity is effectively how much the money there is in that particular market and therefore how likely someone else is able to buy something that is for sale. If theres not enough liquidity in the market, no one will buy the funds that the traders sell. Arbitrage has the effect to cause the prices in different markets to converge. As a result of the arbitrage, the currency exchange rates, the price of the commodities and the price of the securities in different markets tend to converge. However, arbitrage tends to reduce price discrimination by encouraging people to buy an item where the price is low and resell it where the price is high. Arbitrage transactions in modern securities markets involve fairly low day to day risks but can face extremely high risk in rare situations, particularly can lead to financial crises and the bankruptcy. Stock market is basically refers to a particular market where the stocks and the bonds are traded or a place where the stock exchange. Arbitrage can and it does exist in stock market. Different types of stock market may exist of different types of arbitrage. In the concept of the stock market, traders often try to exploit arbitrage opportunitie s to make and attempt the profits. An arbitrageur would short sell the higher priced stock and buy the stock with lower priced in two different stock markets in order to attempt their profits. Besides that, the trader may buy a stock on a foreign exchange where the price has not yet adjusted for the constantly fluctuating exchange rate. The price of the stock on the foreign exchange is therefore undervalued compared to the price on the local exchange and the arbitrageur makes a profit from this difference. If all the stock markets were perfectly efficient, there would never be any arbitrage opportunities but unfortunately markets seldom remain perfect. However, it is important to note that even when the markets have a discrepancy in pricing between two equal goods, there is not always an arbitrage opportunities. Besides that, transaction costs can turn a possible arbitrage situation into one that has no benefit to the potential arbitrager. Don’t waste time! Our writers will create an original "Can Arbitrage Exist In Stock Market Example For Free" essay for you Create order