Arbitrage refers to the exploitation of differences between the prices of financial assets or currency or a commodity within or between markets by buying where prices are low and selling where they are higher. For example, if coffee is cheaper in New York than in London after allowing for transport and dealing costs, it will pay to buy in New York and sell in London. If interest rates are higher on a Euro deposit in London than in Frankfurt, a higher return will be obtained by switching funds from one centre to the other. Unlike speculation, arbitrage does not normally involve significant risks, since the buying and selling operations are carried out more or less simultaneously and the profit made does not depend upon taking a view on future price changes. By eliminating price differentials, arbitrage contributes to the achievement of market equilibrium.


reference: Business Studies / Accounting. Accounts & Finance Glossary. Jim Riley BA(Hons) MBA FCA // tutor2u