What is Arbitrage?

[00:03] process of simultaneously buying and selling an asset to profit from the differences in the price of the asset let's take a look at how arbitrage works in a simplified example imagine we are living in city a city a has two markets

[00:19] living in city a city a has two markets Market a and B in market a the shops are selling berries at thirty dollars per kilogram and just down the street and market B the shops are selling berries at forty dollars per kilogram however

[00:34] most people buying berries in market B don't know that they could buy berries at a much cheaper price at market a and if they knew they will probably walk to market a to buy the cheaper berries the difference in prices is because of

[00:50] imperfect information as a smart businessman you decide to take advantage businessman you decide to take advantage of this so every morning you go to market a to buy the berries at a cheaper price and go to market B to sell the

[01:04] berries at a higher price for every kilogram of berries you sell you earn a risk-free profit of ten dollars from the price difference in the markets in fact in the next few months you became so successful that you start buying large

[01:20] quantities of berries in market a and selling them in market B this affects the demand and supply of berries in market a and B respectively the demand of berries in market a increases so their price increases in

[01:36] market a and the supply of berries in market B increase so their price market B increase so their price decreases in market B eventually the price of the berries in the two markets will become so close together that you

[01:49] can't make a profit from their price differences something similar happens in the financial marketplace as well a company stock could be trading on the New York Stock Exchange for $1 per share and trading on the London Stock Exchange

[02:03] for a dollar and five cents per share an arbitrage or could pocket the difference of five cents per share by buying the stock for $1 on the New York Stock Exchange and selling it on the London Stock Exchange such

[02:18] arbitrage opportunities arise usually because of imperfect information arbitrage is often called riskless profit because it's theoretically a riskless activity traders are buying and selling the same asset simultaneously

[02:34] and pocketing the price difference as profit however the modern technology has significantly reduced arbitrage opportunities the advancement of technology has led to the advent of automated trading systems programs to

[02:50] differences in similar financial instruments these systems are able to detect and act on the inefficient pricing setups so rapidly that the price

[03:02] difference of similar financial instruments and arbitrage opportunity is quickly eliminated there is also another type of arbitrage risk arbitrage risk arbitrage is aren't arbitrage in the truest sense because it's not risk free

[03:17] and speculative in nature a risk arbitrage is usually created by speculation of merger and acquisition here's how it may work tom hears news that company X may be acquired by

[03:32] company y tom thinks that the trading price of company X will increase after the acquisition so he purchases the shares of company X in the hope that he difference between the current trading price and the trading price of company X

[03:49] price and the trading price of company X after the takeover deal however such a strategy is not risk-free because the takeover deal could always break if this was the case Tom might make a loss as the trading price of company X will

[04:03] likely fall after the bad news we hope you learn more about arbitrage from this video if you liked this video give us a thumbs up and subscribe for more educational videos that's coming your way