Arbitrage occurs when traders take advantage of variations of prices in the markets. For instance, a trader can buy a good from a market at a lower price. The same good is then sold in a different market that charges a higher price. A trader in this case, aims at maximizing profits from such transactions. Usually, the profits result from the difference between the selling and purchasing prices. This paper discusses different examples of arbitrages in different financial markets.
Arbitrage happens when traders buy products at low prices and sell them at high prices. A trader can buy large quantities of products from wholesalers at a lower cost. Then sell them to different customers at higher prices compared to the buying price. For instance, a shopkeeper purchases goods from the supermarket at low prices. These goods are further sold to different consumers at higher prices. The profits result from high selling prices to consumers and low supermarket prices.
Arbitrage is also portrayed in the financial markets with the most risk-averse investors. Investors identify two different financial markets within their reach. One with a low bid price and the other that offers a high asking price on the same commodity. An investor would thus buy the stock at the market with a low bidding price. The stock was later sold in another market at a high asking price. Most risk-averse investors engage in these exchanges in different financial markets. Their main aim is to make profits from the difference between the two prices.
When firms are merged or acquired, brokers take advantage of low stock quotations. The brokers buy stock at low bid prices from the companies that are being merged. Later, the stock is sold at high prices to the interested customers in the stock market. The same case applies when companies are merging and there is a low quotation of stock prices.
There is arbitrage in the market when people borrow loans from different lenders. Usually, lenders attach interest charges to loan repayments by borrowers. Normally, borrowers pay the principal amount plus interest charges. The lenders receive excess cash from the amount lent hence, the profit realized.
Bond markets also give a clear example of arbitrage practice among the traders. The relationship between bond prices and the rate of interest is inverse. In that, a low interest rate results in a higher bond price and vice versa. When the interest rate is high in the market, people speculate that the bond prices will rise in the future. Hence, purchasing the bonds at a lower price and selling them when prices rise to make profits.
Overproduction of a given product in a certain area results in its surplus. Places with high production of products charge low prices due to their surplus in the market. Traders take advantage by buying at a lower price and selling the product where it is scarce at a higher price. For instance, an area with a high production of mango in the market. Traders buy them at a throw-away price, then sell them at higher prices in markets where they are scarce.
There is also arbitrage when diverse opportunities exist to undertake investment. Investors prefer high returns investments compared to those with low returns. Two portfolio investors prefer to sell one with low returns and reinvest in one with high returns. The main aim is to maximize the profit from an investment with higher returns.
Foreign exchange markets also exhibit an example of arbitrage in the markets. People get commodities from countries that provide them at a cheaper cost. The goods are then sold in the markets where they are a bit expensive. In import goods, the traders benefit through selling the goods to the country with a deficit at a higher price. Moreover, the exportation of goods results in high prices received from the sales. The profits in both export and import in this case results from the difference in prices.
Risk-averse people practice arbitrage for a short term period in the markets. Markets continue to adjust prices daily, and a correction of these instabilities is possible. Thus, an arbitrager needs to be well-equipped with market information and be alert. This will result in taking advantage of opportunities to maximize profits.