e. explain arbitrage and the role it plays in determining prices and promoting market efficiency.
What is arbitrage?
Arbitrage is a process through which an investor can buy an asset or combination of assets at one price and concurrently sell at a higher price, thereby earning a profit without investing any money or being exposed to any risk.
What is the no-arbitrage principle?
The no-arbitrage principle states that any rational price for a financial instrument must exclude arbitrage opportunities.
What are the two roles of arbitrage?
- It facilitates the determination of prices.
- It promotes market efficiency.
What is a hedger?
A hedger trades futures to reduce some pre-existing risk exposure.
What is a speculator?
A speculator takes a view of the market, and accepts the market's risk in pursuit of profit.