Arbitrage basics | Finance & Capital Markets | Khan Academy

The word arbitrage sounds very effective, but it's basically a very simple idea. In fact, it's just a matter of using the price difference for the same thing to make profits without risk. Let's think about it a bit. Let's say there is a market in one part of the city. For example, the apple market. Apples are sold at the market for $ 1 per apple. In another part of town you have another market. In this part of town, apples sell for $ 1.50 an apple. How can you take advantage of this situation? And we will assume that these apples are completely identical. How can you take advantage of the price difference on these identical things to make a profit without risk? Ideally, you want to sell apples at a more expensive market, where you get $ 1.50 per apple. And you want to buy an apple on a cheaper market, where you get it for $ 1 an apple. That's exactly what you do.

You will go to this market … You buy apples; Let's say you buy 10 apples for $ 10. And then maybe you would ride your bike to another market here and sold their 10 apples. This is buying 10 apples, which you would then sell for $ 15. Make $ 5 instantly without risk. You buy for $ 10 and sell for 15. You can do it over and over again and on each ride, how much the bike can carry. You will continue to make money. This is arbitration. Imagine the side effects. If someone kept doing this, this would result in an increase in the supply of apples here, so supply would rise in this market and demand would increase in this market, because someone constantly buys in this market and sells in this market. So what happens in the end is that increased demand will increase the price in this market and when supply increases in this market, the price decreases.

The theory is that the more you do this, the closer the prices get together. And in the end, you won't make much profit. But when there is a discrepancy, you have the opportunity to arbitrate..

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