Arbitrage

Arbitrage was born with the rise of global trading. Quite simply, arbitrage means you try to buy something cheap in one place, to make a profit selling it somewhere else.

For example, in the international currency markets, there may be a time when Sterling is being quoted at slightly different rates by markets in (say) London and New York. If you could buy one pound in London for $1.9030 and at the same time the selling price was being quoted in New York at $1.9040, as a foreign exchange dealer, you might be tempted to buy currency quickly in London and sell in New York.

Clearly to make any profit out of such a deal, you'd need to be trading in large quantities of Pounds. And on the basis that these markets move very quickly, you'd probably want to complete both ends of the transaction within a few seconds.

In share trading, arbitrage has also come to mean a sophisticated form of betting. Investors called risk arbitrageurs attempt to make profits from an expected rise in the price of a takeover target's shares and a drop in the price of the bidding company's shares. These traders simultaneously buy stock in the target while selling that of the bidder. They will also invest in the target company if they think the bidder will be forced to raise his offer price.

See Also:Moneyextra's Stockmarket Centre

Last Updated: June 2007 © Moneyextra.com

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