Financial Risk Manager Part 1

Explanation

Arbitrage in security trading refers to the exploitation of security mispricing aimed at making risk-free profits. This involves simultaneously buying and selling the same security in different markets to capitalize on price discrepancies. The key characteristics of arbitrage are:

• Risk-free nature: Arbitrage profits come from price differences, not from market movements
• Simultaneous transactions: Buying and selling occur at the same time
• Market efficiency: Arbitrageurs help maintain price consistency across markets

Why other options are incorrect:

Choice A: While exploiting undervalued assets can increase returns, this describes value investing rather than arbitrage. Arbitrage specifically targets price discrepancies between markets.

Choice C: This describes market timing strategies, which involve predicting price movements and carry risk. Arbitrage is risk-free and doesn't rely on timing.

Choice D: This describes illegal activities like tax evasion, which has no relation to legitimate arbitrage trading strategies.

Arbitrage plays a crucial role in financial markets by ensuring price efficiency and eliminating temporary pricing anomalies.