Finance: What is Arbitrage?

What is Arbitrage? Arbitrage is a trading strategy used to make risk-free money. The investor buys a security in one market and sells it in another market at the same exact time that a change in price or pricing error occurs.

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Transcript

00:29

pre-internet era around the world communication well it was relatively

00:34

slow and expensive back then especially when it came to sharing data one [Man talking into olden microphone]

00:38

relatively easy arbitrage or riskless trade opportunity that came about was

00:44

when stocks traded at one price on the various european exchanges versus the

00:50

prices it traded at on the US exchanges like shares of IBM might have been [Share price graph of IBM]

00:55

offered for sale at $165 32 cents on the london stock exchange even net of

01:01

currency conversion prices remember the Brits were on the pound system but in

01:05

the US investors were paying $165 47 cents a share

01:10

so an easy 15 cents a share was made all day long in buying the shares of IBM in

01:16

London and then just selling him back here in New York well both sides of the

01:20

trade were made at the same time it was riskless it was arbitrage and arbitrage

01:26

became a whole industry for a while until the capital markets went to work

01:30

and spreads tightened as communication got more liquid and people sprayed a [Spreads word becomes narrower]

01:35

bunch of wd-40 on information passing around the world and then that 15 cent [15 cents transfers from US to England]

01:40

spread from London to New York became more like a penny or a tenth of a penny

01:44

or at least close enough of a spread so that it was no longer worth bothering to

01:49

try and make a buck or a billion whatever those arbitrageours made in

01:53

those days