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Arbitrage

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Define arbitrage and the law of one price. What role do they play in a market-based system? What do we call the 'one price' of an asset?

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Solution Summary

The expert provides definition of arbitrage and the law of prices.

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According to the risk glossary

"In finance theory, an arbitrage is a "free lunch"?a transaction or portfolio that makes a profit without risk."

Thus it involves buying assets in one market and selling them in another to profit from price differences.

For example Suppose a futures contract trades on two different exchanges. If, at one point in time, the contract is bid at USD 55.07 on one exchange and offered at USD 55.00 on the other, a trader could purchase the contract at one price and sell it at the other to make a risk-free profit of a USD 0.07.

http://www.riskglossary.com/link/arbitrage.htm

Law of one price
Definition
According to the investor words:

"An economic rule which states that in an efficient market, a security must have a single price, no matter how ...

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