arbitrage

Examples of arbitrage in the following topics:

• Arbitrage Pricing Theory

  • The Arbitrage Pricing Theory (APT) is a linear relationship between systemic factors and the return of an asset.
  • Arbitrage Pricing Theory (APT) is a model for asset pricing that was proposed by Stephen Ross in 1976.
  • If an asset is either over- or under-priced, then there is an arbitrage opportunity.

• Overview of Convertible Securities

  • Convertible arbitrage is a market-neutral investment strategy often employed by hedge funds.
  • Arbitrage is the simultaneous purchase and sale of an asset in order to profit from a difference in the price.
  • This diagram illustrates an arbitrage opportunity in foreign currency exchange.

• Chapter Questions

  • Please calculate the cross rate to determine if arbitrage exists.
  • If intermarket arbitrage exists, how much profit could the Citibank trader earn?

• Foreign Exchange Rates

  • Moreover, investors can profit from arbitrage, when currency exchange rates differ between two or more markets.
  • Furthermore, investors could use arbitrage.
  • Currency exchange rates are continually fluctuating, and a banker or investor can profit from price differences, called intermarket arbitrage.
  • Since the exchange rates differ, then arbitrage exists, and we can profit from the exchange rate differences.
  • In the modern age, the international banks use computers to spot differences in exchange rates and quickly execute transactions to profit from arbitrage.

• Interest Rate Parity Theorem

  • International investors use arbitrage to price a forward contract.
  • Consequently, the investors use arbitrage to invest in United States and Malaysia until the rates of return for both countries converge to the same rate.
  • However, this analysis assumes arbitrage brings the two investments into equality.
  • Thus, arbitrage ensures we set the source of funds from the foreign country equal to the use of the funds for the domestic country, yielding Equation 35.
  • Arbitrage adjustment process can be slow, and rates of returns can differ between countries.

• Differential

  • In a theoretical market with perfect information, perfect substitutes, and no transaction costs or prohibition on secondary exchange (re-selling) to prevent arbitrage, price differentials can only be a feature of monopolistic and oligopolistic markets, where market power can be exercised.
  • The airlines enforce the scheme by making the tickets non-transferable, thus preventing a tourist from buying a ticket at a discounted price and selling it to a business traveler (arbitrage).

• International Fisher Effect

  • Consequently, arbitrage drives the rate of returns together.
  • Then we set Equations 17 and 18 equal to each other because international arbitrage causes both investment returns to converge to the same rate, shown in Equation 19.
  • Once investors have exhausted their arbitrage opportunities, they stop moving their capital to the foreign country.

• Fama-French Three-Factor Model

  • Like CAPM and the Arbitrage Pricing Theory, the Fama-French three-factor model is a linear model that relates structural factors to the expected return of an asset.

• Purchasing Power Parity (PPP) Theory

  • If a price difference exists between two markets, then arbitrage is possible.
  • Eventually, arbitrage stops, when the prices converge between both countries.
  • If the spot exchange rate is 1.4 francs per $1, subsequently, traders use arbitrage.

• Implications for Variance