6. Arbitrage

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.